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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.
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