Balloon Payment in Business Loans

In a loan that has a balloon payment, the terms of the loan require the Borrower to pay a larger final payment than previous smaller payments to settle the outstanding loan. This is called a balloon payment. It is normally the loan Principal that is paid in the balloon payment.

Why Would a Borrower Agree to a Balloon Payment Loan?

It may seem unusual that a Borrower would agree to enter into a loan agreement in which a sizeable portion of the loan is paid at the end of the loan term.

However, it can make sense if the Borrower wants to make smaller payments early on in the loan term to reduce its expenses because it expects to have sufficient larger funds in the future.

A common example where this occurs is when the Borrower needs a bridge loan today while it is in the process of selling a major business asset or even selling the entire business itself. By the end of the loan term, the asset or business is expected to have sold and the balloon payment is paid to clear the outstanding loan.

Common Balloon Payment Structure

The most common deal structures are:

  • The Borrower pays a portion of the Principal plus Interest in monthly instalment payments. Then, it pays off the remaining portion of the Principal at the end of the loan term, that is, at maturity.
  • The Borrower makes monthly instalment payments of Interest only. Then, it pays off the entire Principal amount at maturity.

    Refinancing the Balloon Payment Loan

    The truth is, most balloon payment loans have a refinancing clause inserted in them. This means that the balloon payment is not made, the loan is refinanced before its maturity date. The loan is settled by replacing it with a new loan.

    This is beneficial to the Borrower that doesn’t have to make the balloon payment and it’s beneficial to the Lender that gets to continue to receive interest on a brand new loan over an extended period of time.

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