There are many kinds of loans available to help you cover the costs of running your business. For instance, there are online small business loans that require monthly payments that are automatically deducted from your bank account.
One unique option is loans that come with what is termed a “balloon payment”. Read on to discover the pros and cons of a small business loan with a balloon payment.
What Are Balloon Payments?
Online small business loans typically require you to make fixed monthly payments until the balance of your debt has been repaid. Depending on your lender, the loan period can be up to 30 years for a mortgage or five years with an auto loan. Small business loans from alternative lenders might require the debt to be repaid within three years. Each monthly payment covers interest and principal.
A balloon payment is a one-time final payment that concludes your debt payment obligations. Taking a loan with a balloon payment means that your monthly payments are lower, sometimes covering only the interest. These loans have shorter borrowing terms.
If your small business is experiencing a cash flow problem or you haven’t established a strong credit history, this type of loan can help you get the money you need. The loan terms might require the balloon payment after three years, during which time you can demonstrate your ability to handle a more traditional loan.
How Businesses Typically Use Balloon Payments
There are advantages to taking out a small business balloon loan. Chief among them is that this loan puts capital in your hands when you need it. From month to month, your payments are lower, giving you breathing room and time to reach your revenue projections.
Here are some examples of when you might want to take out this type of loan.
- Gap Financing – This loan is advantageous when you’re waiting for customers to pay you, but you need equipment financing now to meet the needs of your consumer base. Unlike a merchant cash advance, which is also based on anticipated income, a balloon loan doesn’t depend on credit card sales.
- Purchase Commercial Property – You’re ready to move out of leased space and buy your own facility, but you don’t have the cash. A loan that’s due in five years, for example, means that you can buy property, and in the meantime, increase your cash flow.
- Find the best deal for your old premise – Alternatively, if you need larger facilities but haven’t sold your current space, this loan type gives you the time to find the best deal for your old premises.
Balloon Payments Pros
- Smaller Payments – Because you pay only interest, your monthly payments are smaller than they would be with a traditional small business loan. This gives you time to improve your profit margin.
- You Qualify For A Larger Loan – The smaller monthly payments make it easier to qualify for a larger loan.
- Available Even If You Lack Credit – This loan is an option even if you haven’t yet built a credit history. The loan will help you develop a credit score that’ll position you for more conventional small business loans in the future.
- Improves Your Cash Flow – The money that you save due to smaller monthly loan repayments can be used to cover the costs of inventory, staffing, equipment, marketing, and other expenses.
Balloon Payments Cons
- The Balloon Payment Is Large – The payment at the end of the loan can be a significant burden on your cash flow. If you decide on this type of loan, you need to save for the final payment.
- Higher Interest Rate – The interest rate for these loans is typically higher than for a conventional business loan.
- Riskier – It’s risky to assume a loan that requires a significant lump payment. You have the option of refinancing, but there’s no guarantee. If you default on the final payment, you face foreclosure, which damages your credit score and invites collection actions.
- Loss Of Collateral – If you secured a loan with collateral, and you’re unable to make the final payment, you risk forfeiting the collateral.
Many small businesses find it advantageous to take out a business loan with balloon payments, especially for short-term financing needs and to purchase commercial real estate. These loans are a good way to meet your equipment financing needs also.
If you’re a new business without a strong credit history, you can still qualify for these specialty loans. Online small business loans that offer a balloon option help you cover the gap in cash flow while you wait for customers to pay for your products or services. The final payout, though, is significant. Therefore, be cautious when borrowing with this loan type.