A balloon payment is an unusually large payment that is due at the end of a loan. A balloon payment is frequently designed to be rolled into a new loan rather than being paid, thereby generating additional business for the lender. This payment format is especially useful for borrowers who do not have sufficient cash flow to make incremental payments over time. A balloon payment differs from the more traditional payment format, in which borrowers pay down a portion of the loan principal with each payment made, and not just the interest portion of the loan.
Loans with balloon payment features present a risk for lenders in a down market, when borrowers are less likely to pay off the loans or roll them forward. Instead, these loans are more likely to go unpaid, and so must be written off.