A balloon loan or balloon mortgage can be considered the opposite of amortization. In the case of amortization, the loan is paid off in installments on a monthly basis until the loan clears off in the stipulated period.
However, with a balloon mortgage, the person taking the loan can pay the loan off in a lump sum only when the loan matures. There are numerous variations of the balloon mortgage.
The first variation is that the borrower has to only pay the interest rates in the initial months, and when the loan period matures, they have to pay off the entire mortgage amount. In another variation, the borrower might not have to pay any money at all during the initial months or years and can finally clear the loan by paying it when the period ends.
There are numerous other variations where the borrower opts for either fixed-rate or variable-rate interests and also decides to structure the mortgage such that after paying a small amount for a few months, the balloon loan or balloon mortgage can roll over into an amortization schedule.
Usually, people make balloon loans for one of the primary reasons. One is that they expect to earn more in a few years and will be able to handle the loan payment. The second one is that they might only want to live in a particular home for a short period of time. This way, they have to pay much less and can clear the loan within a few years than prolong mortgages for 20 or 30 years.
Balloon mortgages usually span over 3 to 7 years and not longer than that. This is because it is, either way, risky for all the parties involved. Since the lump sum is enormous, there is a big chance that borrowers might be unable to pay for the loans, resulting in a lot of hassle for both the borrower and the bank.