How A Balloon Mortgage and Payment Works

What is a balloon mortgage or balloon payment?

2 Answers

A balloon mortgage is a short term, non-amortizing loan available to real estate purchasers. These mortgages typically have lower monthly payments and interest rates and can be easier to qualify for than a traditional 30 year fixed loan plan. Unlike many other mortgages, balloon mortgages do not pay themselves off at the end of the loan term. At the end of the term, a portion of the principal remains and must be paid off in one lump-sum payment, known as the " balloon payment." Balloon mortgages are usually fixed-rate mortgages, but the monthly payments borrowers make most likely include only the interest. Though the payments are usually based on a 30-year amortization schedule, and terms for balloon loans can range anywhere from 1 to 25 years, the balance will usually come due after a short time period - three to five years.

For example, if a buyer obtains a seven-year balloon mortgage to purchase a home, he has seven years of equal monthly payments at a fixed interest rate. This rate is often lower than what the buyer would otherwise be able to secure under a traditional mortgage loan. At the end of the seven years, the balloon payment of the remainder of the balance of the loan is due, and the borrower must either pay it in full, refinance with the same or a different lender, or sell the home.

What are the advantages to using a balloon mortgage? Most borrowers use the balloon mortgage when they intend to sell the home before the balloon payment is due. For example, homebuyers who know that their employer will relocate them to another city or state within a few years often opt for a balloon mortgage. Some individuals use allotted years of lower payments to better invest and leverage their money. At the end of seven years, some homeowners can pay off the balance in full. Most, however, are not able to afford this payment and will choose to refinance with the existing lender or a new lender at that point in time. Refinancing is the simplest way of renewing the mortgage. The rates charged when renewing with the same lender may exceed those available from a new lender. Moreover, balloon loans generally offer the borrower a non-negotiable predetermined refinance option in case they have difficulty paying the balloon payment. Refinancing with another lender gives the borrower the chance to negotiate a new loan with a better interest rate and more appealing repayment options.

What are the disadvantages? There are several risks associated with balloon mortgages. At the conclusion of your loan term, you will have to pay off your outstanding balance, or the principal, according to your own arrangements. Borrowers who are unable to make the final payment may have to refinance, sell their home, or convert the balloon mortgage to a traditional mortgage at current interest rates. Also, since a balloon mortgage does very little to pay down a borrower's principal, it is not an effective way to build equity in one's home.

The option of making early repayment only lies with the balloon mortgages or else it can be extended up to a 30 year mortgage with fixed rate along the option to be embedded. If the total debt repayment would be compared according to conventional fixed rate mortgage, these balloon mortgages are quite lower. They can be termed to be the form of partially amortized mortgage or interest only loans.