A balloon loan is a kind of long-term loan that requires the borrower to pay the full amount, otherwise known as the balloon payment, once the loan matures. They may also be referred to as bullet loans or balloon notes. Balloon loans are not subject to amortization during the term.
One of the benefits of taking out a balloon loan is the lower interest. Since payments do not have to be made before the loan reaches maturity, the borrower has more freedom to make use of the capital as he wishes during the course of the loan. As such, he is more flexible and can make other purchases as necessary all throughout this period. It is possible for the borrower to reinvest a portion of the capital, in the hopes that the money will earn more than is required for the payment at the end of the term.
Taking out a balloon loan may not be for everyone. Although interest rates will often come out lower, there is a higher risk associated with a balloon loan. It requires a greater amount of discipline from the borrower to make sure that the final payment can be made in full, despite any spending that was made before loan maturity. It also requires the borrower to be able manage his own money so that he can borrow from himself and return what he borrowed in a timely manner. It is also possible for the interest to be reset at a higher rate later on. Such loans are usually granted only for larger amounts such as home mortgages and not for small purchases.