A balloon loan is a type of loan that features lower monthly payments for a set period of time, followed by a large lump sum payment, the balloon, due at the end of the loan term.

Some key features are lower monthly payments during the initial term, which is often five, seven, or ten years, and it's followed by a large final payment, the balloon, which is required to pay off the remaining balance.

Typically, balloon loans are used for short term financing needs or by borrowers who plan to sell or refinance before the balloon payment is due.

For example, if you took out a seven year balloon mortgage for 250,000, you would make monthly payments based on a thirty year amortization schedule, but at the end of year seven, the full remaining balance, often over 200,000, would be due all at once. Here are a couple pros and cons.

A couple pros: you'll have lower monthly payments upfront and it may be a good option if you don't plan to stay in the home long term.

A couple cons are that they are high risk if you can't sell, refinance, or pay the balloon amount when it's due, and it can be harder to qualify for and less common in today's lending environment.

Balloon loans can be beneficial in very specific situations, but are generally considered high risk and require a solid exit strategy.

Just so you know, balloon payments are not allowed on conforming loans backed by Fannie Mae or Freddie Mac, nor are they allowed on government backed loans like FHA, VA, or USDA, and here's why. Government and conforming loans must meet strict guidelines, which include standardized repayment structures.

These agencies require fully amortizing payments, meaning the loan is paid off over the life of the loan with no large lump sum due at the end. Balloon features introduce repayment risk, which is inconsistent with the goal of long term stability in the conforming loan and government loan market.

Exceptions and alternatives are balloon payments may still exist in nonconforming or portfolio loans held by private lenders. Some jumbo, commercial, or private financing products may include balloon features. For borrowers needing flexibility or shorter term solutions, adjustable rate mortgages, also called ARMs, or interest only periods may be safer alternatives to explore.