In which scenario would a balloon payment typically be necessary?

A balloon payment is a larger-than-normal final payment due at the end of a loan. This payment is typical in the context of loans that have not fully amortized over the term. In such loans, the borrower makes regular payments that are lower than what is typically required to completely pay off the loan by the end of the term. As a result, at maturity, the remaining balance, which has not been reduced to zero through these payments, becomes due as the balloon payment.

This structure is commonly used in commercial loans and some types of short-term financing where the borrower may not intend to keep the loan for its full term. Instead, they might plan to refinance or sell the property before the balloon payment is due. Since the regular payments do not cover the full amount of the principal over the amortization period, the borrower should be prepared for a significant final payment.

In contrast, fully amortized loans are designed so that the borrower pays off the entire balance throughout equal payments over the life of the loan, meaning there would not be a balloon payment. Similarly, refinancing a fixed-rate mortgage typically involves adjusting the existing loan terms rather than necessitating a large final payment, and selling the property before maturity may involve settling the loan without a balloon payment but