Key Takeaways
- Balloon mortgages offer low payments initially, but require a large final payment.
- These loans are ideal if you plan to sell before the term ends.
- Refinancing is an option to avoid the final balloon payment.
- Consider potential risks if refinancing or selling isn't feasible.
Article Summary
A balloon mortgage is a home loan that offers a low, fixed interest rate for a short period, usually five to seven years. At the end of this period, the remaining loan balance is due in a single, large payment, known as the "balloon payment."
Balloon Mortgage: Explained in Plain English
A balloon mortgage differs from traditional fixed-rate mortgages in structure and payment schedule.
At first glance, balloon loans appear similar to a 30-year fixed-rate mortgage, offering relatively low, stable monthly payments. However, the term of a balloon mortgage is shorter than a typical conventional or FHA mortgage, ranging between five to seven years.
The defining feature of a balloon mortgage is the large sum, or "balloon payment," due at the end of its term.
The balloon payment due is the remaining principal balance on the loan when the loan term ends. It represents whatever balance has not been paid off.
Homeowners with balloon mortgages have only three options at this point:
- Pay the balloon payment in full
- Refinance the mortgage for a new loan term
- Sell the home to satisfy the debt
The primary appeal of a balloon mortgage is lower interest rates and monthly payments, making it an attractive option for first-time home buyers who plan to sell their home before the balloon payment comes due.
However, balloon mortgages carry risk.
If the home buyer's financial situation does not improve as expected, if property values decline, or if refinancing is unavailable due to a low credit score or other reasons, the balloon mortgage's lump sum can create a substantial financial burden.
Balloon Mortgage: A Real World Example
A first-time home buyer purchases a $300,000 home in 2020 with a 5-year balloon mortgage at 3.50% interest. The monthly payment is significantly lower than a traditional 30-year mortgage would have been at the time.
The buyer planned to relocate for work within 4 years, expecting to sell the home before the balloon payment came due. However, in 2023, their job situation changed and they decided to stay in the area long-term.
With the balloon payment of $280,000 due in 2025, the buyer refinanced into a 30-year fixed-rate mortgage at current mortgage rates. While the new monthly payment increased to $1,850, it eliminated the risk of the large lump-sum payment and provided long-term stability.
Common Questions About Balloon Mortgages
Frequently asked questions about balloon mortgages and how they work.
What happens if I can't make the balloon payment?
If you can't make the balloon payment when your mortgage comes due, your options as a homeowner are to refinance the loan, sell the property to cover the debt, or, in the worst-case scenario, face foreclosure.
Is a balloon mortgage riskier than a 30-year fixed-rate mortgage?
Yes, balloon mortgages are generally riskier than other mortgage types because of the lump sum payment due at the end of the loan term, and the uncertainty surrounding refinancing or selling a home.
Can I refinance a balloon mortgage?
Yes, many homeowners with balloon mortgages refinance them before the balloon payment is due, assuming they meet the refinancing requirements at that time.
Are balloon mortgages common?
Balloon mortgages are less common than other long-term mortgages and are generally used with specific financial strategies, or in situations where the borrower plans to sell or refinance the property within a few years.
