What it is:
How it works/Example:
To understand balloon interest, one must first understand term serial bonds (or installment ) describes a that matures in portions over several different dates.
Normally, when a company or government body , all of those mature on the same date (that is, the borrower must repay all of the debt on one particular day). A serial , however, matures over several periods (usually at regular intervals).
For example, the of $100 million in traditional with 10-year have to make a $100 million principal payment at the end of the 10th (see the table below). But the issuer of $100 million in serial might structure the such that $20 million matures after five , another $20 million matures the after, $20 million the after that, and so on.
Balloon interest means that therates on these serial gets progressively higher with . So, the maturing in 6 might carry a lower than the ones that mature in 7, and 7's might carry a lower than the ones that mature in 8, and so on.
Why it matters:
Balloon interest encourages savings, assuming the is able to make the promised repayments, even if the rates get progressively higher.
Serial also allow the to time the dates to the income from the project financed by the proceeds. This is why so many municipal bond are . This strategy requires to complete their projects on time, however.