A balloon loan is characterized by a payment that has to be made at the end of the loan term. This payment involves higher numbers than the initial period of the loan, hence the term balloon loan. A balloon loan is also sometimes known as a bullet loan.
This kind of loan is usually a long-term loan, and is usually applied to mortgages, although not exclusively.
The reason for a huge payment upon the maturity of a balloon loan is that the interest rates applied to this kind of loan are usually very low. The result is that the borrower does not have to pay substantial amounts at the beginning of the loan term. One benefit of this arrangement is that the borrower does not have to lay out much money to pay off the loan immediately. The time before the maturity can be spent to gain more capital, which can be put towards the balloon payment when the time comes.
On the other hand, since majority of the loan amount will be paid off upon maturity, the borrower has to be able to exercise enough discipline to ensure that there will be enough cash to pay off the loan.
A balloon loan is an attractive choice for those individuals who have are facing a purchase that cannot wait, such as a prime piece of real estate, but do not currently have the money to buy it.