Definition:
A balloon payment is a large, lump-sum payment due at the end of a balloon mortgage or loan term, significantly larger than previous regular payments.

Example:
Imagine Sarah has a balloon mortgage with monthly payments of $1,200 over five years. At the end of those five years, she faces a balloon payment of $150,000—covering the remaining principal balance of her loan.

Explanation:
In real estate financing, balloon payments occur when loans are structured to have lower initial monthly payments by deferring a large portion of the principal until the end. During the loan term, payments may seem affordable since they're calculated as if spread over a long-term mortgage (often 30 years). However, after a shorter period (usually 5–7 years), borrowers must pay off the remaining balance in one sizable lump sum—the balloon payment.

Borrowers typically prepare for this by either refinancing, selling the property, or saving money to cover this large payment when it comes due.

Importance:
Understanding balloon payments is crucial because of their significant financial impact. For homebuyers, balloon payments present potential risk: failing to prepare can lead to default or foreclosure if refinancing or selling isn’t feasible. It’s essential for buyers to have a clear financial plan to handle the balloon payment.

For sellers, recognizing potential challenges buyers might face with balloon mortgages can influence negotiation strategies, especially regarding property financing and closing timelines.

In short, balloon payments offer initial affordability but require careful financial planning to manage the substantial lump-sum payment at the end of the loan term.