Balloon Maturity - Explained
What is a Balloon Maturity?
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Table of ContentsWhat is a Balloon Maturity?How Does Balloon Maturity Work?Balloon Maturity in Mortgages
What is a Balloon Maturity?
Balloon maturity means that the principal or face value of a debt instrument is due in a single, lump-sum payment at the end of a stated period. This term is mostly used in bond issuing. It is also quite risky planning for balloon maturity and issuing bonds. The issuer must be able to meet the demands of the bonds issued and other payments. For example, if a bank decides to issue a bond in a year that will mature in 10 years, it must be able to pay the principal of the bonds when due and also meet the coupon payments for a period of ten years.
How Does Balloon Maturity Work?
Another way to avoid the risk of balloon maturity is by issuing serial bonds. Serial bonds are paid at regular intervals unlike being paid in total at a particular point in time. They are used to fund substantial projects that lasts for several years. Serial bonds mature gradually over a time frame. For instance, an issuer can prevent paying a huge sum when releasing 500 bonds that has matured gradually for a period of 5 years. Serial bonds allows for a monthly payment rather than paying an exorbitant fee of balloon maturity.
Balloon Maturity in Mortgages
Balloon maturity is basically derived from bond transactions, but recently used to refer to a final large sum of money in a debt repayment plan processed at a specific time. This repayment could be on mortgages, commercial loans and other debts. When a balloon maturity is used in a mortgage, there will other smaller payment followed by a huge sum of balloon payment. This balloon payment is usually the last payment. An increased balloon payment indicates that while other smaller payments has been done, the debt has not been amortized. The process of amortization involves creating a plan of regular payments of both interest and principal. Most payment made goes to reducing the principal but early payment reduces the interest paid and also the principal amount paid. A repayment schedule or plan can benefit a company that has shown high tendency to grow within the next 10 or 15 years the loan term will expire. At that point in time, the company should have enough profit to cover the balloon payment. Asides company whose profit is low and will be needing a loan, individuals too might choose to go for a home mortgage as a result of low income. This individual might have anticipated a large sum of income in the future, an inheritance or property sale which would allow for the balloon payment when due. inability to pay the balloon payment will require a financing the mortgage again or selling the acquired property.