Legal Definitions - balloon note

A balloon note is a type of loan characterized by a series of relatively small, regular payments followed by one significantly larger final payment, known as the "balloon payment," which pays off the remaining principal balance. This structure often results in lower monthly payments during the initial period, but requires the borrower to either pay off the substantial final sum or refinance the loan when it comes due.

• Example 1: Commercial Property Purchase

  A small business owner wants to purchase a commercial building for their operations but anticipates a significant increase in revenue within five years. They secure a 5-year balloon note from a private lender. For the first 59 months, they make manageable, interest-only payments, which helps preserve their cash flow for business growth. In the 60th month, the entire remaining principal balance of the loan is due as a single, large balloon payment. The owner plans to either sell a portion of their business, secure a traditional long-term mortgage, or use accumulated profits to cover this final payment.

  This example illustrates a balloon note because the borrower benefits from low initial payments but must prepare for a substantial lump sum payment at the end of the loan term, which they intend to cover through future financial growth or refinancing.

• Example 2: Land Development Financing

  A real estate developer acquires a parcel of undeveloped land with the intention of obtaining permits and beginning construction within three years. To finance the land purchase, they take out a 3-year balloon note. For the duration of the note, they make minimal monthly payments. At the end of the three years, the full outstanding principal amount of the loan is due. The developer expects to have secured construction financing by that time, which would allow them to pay off the balloon note and roll the land cost into the new, larger construction loan.

  Here, the balloon note provides short-term financing with lower initial costs, anticipating that a future event (securing construction financing) will provide the funds to satisfy the large final payment.

• Example 3: Private Equipment Loan

  A startup manufacturing company needs specialized machinery but doesn't yet qualify for a conventional bank loan. An angel investor provides them with a 4-year balloon note to purchase the equipment. The company makes small, fixed monthly payments for 47 months, which helps them manage their early-stage expenses. In the 48th month, the remaining principal balance of the loan is due as a large balloon payment. The company projects that by this time, their production will be robust enough to either generate sufficient profits to pay off the investor or to qualify for a traditional equipment loan to refinance the remaining balance.

  This scenario demonstrates a balloon note where the borrower benefits from reduced payments during a critical growth phase, but is obligated to make a significant final payment, relying on future business success or refinancing to meet that obligation.