The risk that a borrower will fail to make a balloon or lump-sum payment at maturity. Balloon risk may arise from inability of a borrower to arrange for refinancing at the balloon payment date or impossibility to sell the underlying asset (collateral, if any) to obtain necessary funds out of the proceeds to pay off the balloon outstanding amount.
In relation to a mortgage loan, it represents the mortgagor‘s inability to pay off the mortgage at maturity through refinancing or sale of collateralized property. Individual tranches, within a securitized structure, (e.g., CMBS), are affected by balloon risk. At the whole-loan level, balloon risk is low, but at times the total credit risk and balloon risk may affect investment-grade CMBS tranches (significantly impacting their values).
It is also known as an extension risk or a refinancing risk (as the loan will be extended during the so-called work-out period).
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