A beginner's guide to loans: What's a balloon payment?

A balloon payment is a one-time larger-than-usual payment made at the end of a loan term, that usually occurs when interest rates rise or through postponing loan payments. As you can see, balloon payments aren't as fun as they sound. The good news is that there will be times when you can avoid having to make one. Unfortunately, there will be other times when you won't. 

Either way, we think it's necessary to tell you about balloon payments, especially if you're currently paying off a loan or considering taking out one.  

But before we go into them, let's start with a refresher on the following: 

• Loan term: refers to the time it will take you to pay off a loan in full. Loans can be short-term or long-term. For example, car loans have shorter terms and usually take 3 to 6 years to repay.

Whereas mortgage loans have long terms and can take 10 to 30 years to repay. 

• Principal: refers to the sum of money you borrow in a loan. It doesn't include interest.  

• Interest rate: refers to the amount of money a bank will charge you on top of the amount you want to borrow so you can buy assets like cars or property. Basically, it's the cost of borrowing money.   

Typically, your monthly instalments remain the same over the life of your loan. Some of each instalment covers your interest, and the remainder pays off your principal. However, if balloon payments are involved, your loan structure will look differently. To demonstrate this difference, we must go into the 2 scenarios that may lead to a balloon payment:

The Central Bank of Jordan raises interest rates 

If this scenario happens, your loan's initial interest rate changes. But don't panic because your monthly instalments won't reflect the higher interest rate right away. 

Sometimes, the difference between the initial interest rate and the higher one will  accumulate into a single final payment: a balloon payment. Some banks increase the loan’s tenure, and others divide the extra interest on current payments.  

You postpone your monthly payments

In this scenario, if you choose to postpone a payment for any given month, the interest portion of your monthly instalment will also accumulate into a balloon payment you must pay at the end of your loan. The principal portion will be spread over your upcoming instalments.. But this may not be the case at other banks, and they could have different terms and conditions regarding instalment postponement. So, always remember to read the fine print!

While postponing a loan instalment or multiple may help when you're in a tight spot, remember that doing so is risky because you'll have to shell out an even higher payment at the end. 

You should always contact your bank if you scramble to make a balloon payment. Some banks may agree to modify the terms and conditions of your loan, distribute your balloon payment over your remaining monthly instalments, or extend the length of your loan. 

There’s always a solution, so always be patient and talk to us. We’re always ready to help you make the best financial decisions at any period of your life, because we’re making tomorrow together.