What Is A Balloon Mortgage?

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.”

A Longer Definition: Balloon Mortgage

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:

1. Pay off the balloon payment in full
2. Refinance the balloon mortgage into another mortgage
3. Sell the property to repay the outstanding balance

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.

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Balloon Mortgage: A Real World Example

Imagine a first-time home buyer who uses a 5-year balloon mortgage to finance a home.

Before the 5-year term ends, the buyer expects to sell the home and move to a different state.

Sometime during those first five years, though, the home buyer’s plans change. They refinance the home into a 30-year fixed-rate mortgage at current mortgage rates to ensure a lump sum payment never comes due.

Common Questions About Balloon Mortgages

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.