Ballon payment is a type of loan that requires a huge-sum payment (balloon payment) at the end of the term.
Ballon payment divides your loan into fixed payments that require you to pay off the principal at the end of the stipulated period.
As a conventional loan requires you to pay it back in full at the end of the term, leaving you with no debt to the lender, a balloon loan prevents this from happening since the borrower will only have to make small payments for a predetermined period while the huge principal is paid at the end.
How Do Balloon Payments Work In South Africa?
There are several ways a balloon payment work. However all these forms of payment still requires you to pay a hefty sum at the end of the loan term.
The typical balloon payment, which we are all used to, is structured in a way that the loan initial payments will be lesser while the final payment will be greater.
For example, let’s say you’re taking out a R200,000 loan to start a farm and you decide on a balloon loan of 7-year balloon payment and a 3 percent interest rate, amortized over 30 years. Then your recurring monthly mortgage payment will be R1,079 for principal and interest. A principal balance of R167,561 would be left after the seven-year mortgage term. And everything would be due at once.
Other form of balloon payments are:
Other Types Of Balloon Payments In South Africa
Interest-only Repayment
Interest-only balloon loan have a repayment period where you only have to pay interest. For this, you’ll only pay the loan’s monthly interest rate. But at the end of the loan, the entire initial principal balance is paid.
No monthly Payments Loan
No monthly Payments Loans are balloon payments with zero monthly payments. You’ll come across this type of loan in fix-and-flip situations, where a year or two of interest is considered a part of the cost of a rehab project.
What Differences Does Balloon Payment Have From Other Loan Types?
Compared to other loan types, balloon loans are riskier, but borrowers frequently choose them for a particular reason – low-interest rates and the balloon payment is only due at the end of the loan term.
Traditional Loans
Predictability is the main difference between a balloon and a conventional loan. In both, the borrower is completely aware of the payment amount and time frame. You also know when your mortgage will be paid off.
With a conventional loan, your balance is repaid in full at the end of the term, leaving you with no debt to the lender, but for a balloon loan, the borrower will make payments on a balloon mortgage for a predetermined period of time.
Adjustable-rate Mortgages
An adjustable-rate mortgage’s interest rate is set for a specific number of years. After that, it periodically modifies in accordance with market circumstances. Due to the short maturity terms of balloon mortgages, the majority of them have fixed rates.
A balloon mortgage might be better suited to be replaced with an adjustable-rate mortgage. If you are unable to sell or refinance after that first period, since you won’t have to make a sizable lump sum payment.
Government Loans
Borrowers who might not be able to qualify for a conventional mortgage can also opt for Government loans. If you have a low credit score or the inability to put down a sizable down payment, you’ll still be able to get a government loan provided you have a national identity card.
Advantages of Balloon Loan
- Balloon loans have a lower interest rate than either fixed-rate or adjustable-rate mortgages.
- A balloon loan is good for people who only intend to buy a property for a brief period of time. For example, if you buy a house on a Ballon loan, you can easily sell the house before making the final hefty balloon payment and use the payment to clear your loan.
- People who receive substantial bonuses but earn a modest salary may also consider this option. With a balloon loan, they could budget for the monthly mortgage payments and apply the larger annual lump sums to the balloon payment.
- Even if your credit score isn’t very good right now, you are confident that it will improve significantly over time and you would be able to refinance before the balloon payment is due in this situation.
Disadvantages of Balloon Loan
- A balloon mortgage carries a sizable risk. If you don’t intend to your property before the balloon payment is due, you should expect to refinance their balloon loan into a regular fixed-rate or adjustable-rate mortgage before having to make that hefty payment.
- Although the monthly cost of your property might be reduced using balloon payments, still, it won’t reduce the cost of your loan. Perhaps while some people might profit, you should be aware of the risks, which include losing your balance or even having your property repossessed.
- Refinancing a mortgage loan with negative equity is difficult. Before they will approve your request for a refinance, the majority of lenders demand that you have at least 20% equity on your home, making it difficult to get a refinance.
- Another drawback attached to balloon payment is the fact that people who take up loans with balloon payments are at a big risk because they are only required to pay a small portion of the principal amount while they are left with a bigger debt.
Conclusion
Despite the drawbacks attached to balloon payment, you still get to enjoy some benefits using balloon loan because it makes your monthly payments smaller – which is the primary benefit.
Hence, your monthly payments will remain low and more manageable because you are only paying off your interest. In addition, it will help you save. The amount of your balloon payment will be disclosed upfront, and as a result, you may begin saving for it as soon as your loan is disbursed and earn interest on funds that would have otherwise gone to your lender.