Balloon Loan

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DEFINITION of 'Balloon Loan'

A type of loan which does not fully amortize over its term. Since it is not fully amortized, a balloon payment is required at the end of the term to repay the remaining principal balance of the loan.

BREAKING DOWN 'Balloon Loan'

Balloon loans can be attractive to short-term borrowers because they typically carry a lower interest rate than a loan with a longer term. However, the borrower must be aware of refinancing risk and/or the risk that the loan will reset at a higher interest rate.

Some balloon loans, such as a five-year balloon mortgages, have a reset option at the end of the five-year term that allows for a resetting of the interest rate (based on current interest rates) and a recalculation of the amortization schedule based on a remaining term. If a balloon loan does not have a reset option, or frequently even when it does, it is expected that the borrower will sell the property or refinance the loan before the end of the original loan term.

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