Final answer:
A balloon payment is a lump-sum payment that is due at the end of a partially amortized loan term to cover the remaining principal balance. With partially amortized mortgages, the monthly payments cover only a portion of the principal, leading to a large balloon payment at the end of the loan term.
Step-by-step explanation:
Balloon Payment and Partially Amortized Mortgages
A balloon payment is a large, lump-sum payment required at the end of a loan term. It is characteristic of partially amortized mortgages. With these types of loans, the borrower pays a combination of interest and principal over time, but the payments are not enough to fully pay off the loan by the end of the term. Hence, a balloon payment is made at the end to cover the remaining principal balance on the mortgage.
For example, consider a 30-year partially amortized mortgage. The borrower would make monthly payments based partly on a 30-year payback period. However, the loan might be structured to end after 15 years, at which point the remaining principal amount is due in a single balloon payment. This balloon payment is often much larger than the prior monthly payments because it includes a significant portion of the principal that hasn't been paid off during the amortization period.
Partially amortized loans can be attractive because they offer lower monthly payments initially. Yet, the borrower must be prepared for the balloon payment when it becomes due, which may require refinancing or selling the asset purchased with the mortgage. Essentially, these mortgages are a way of temporarily keeping payments lower at the cost of a large payment later on.