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Balloon mortgages often have low interest rates and monthly payments, but they pose a big risk for most homeowners.
With a balloon mortgage, your monthly payments don't cover the full mortgage and at the end of your term you have to make a lump-sum payment or refinance
Balloon mortgages are most common for commercial projects
With a traditional mortgage, you pay off the entire loan amount over the amortization period. If you have a 30-year mortgage, you can pay off the whole loan in 30 years. With a balloon mortgage, you have a short loan term, typically about seven years, where some of the mortgage is still unpaid at the end of the term. At the end of the term, you make a “balloon payment” to pay off the remaining loan balance.
In general, balloon mortgages are only used for construction and commercial real estate projects. They allow a company to secure a short-term mortgage without having collateral. For example, a company may be able to get a five-year balloon mortgage for a building they intend to construct in three years. When construction is finished in three years, they will either have the necessary collateral to refinance the loan or they will have money from the sale of the building to pay the lump sum.
Balloon mortgages aren’t popular for regular homeowners, and some lenders won’t even offer them. Once a popular option for borrowers, balloon mortgages played a part in the 2008 housing crisis, as mortgage lenders would extend balloon loans to borrowers who couldn’t necessarily afford them.
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A balloon mortgage is any mortgage that doesn’t completely amortize over the term of the loan. So unlike a traditional mortgage, you reach the end of the term and some of the mortgage still hasn’t been paid off.
Once the mortgage term ends, you will need to pay off the remaining loan balance with a lump-sum payment. This “balloon payment” will be significantly more than what your regular mortgage payments were.
Balloon mortgages can vary quite a bit in structure. Some have a fixed interest rate while others have an adjustable rate. You may also find interest-only loans for some short-term mortgages. In this case, your final lump-sum payment would be the entire principal. (This type of interest-only mortgage was more common before the real estate bubble burst in the mid 2000s.)
The enticing aspect of balloon mortgages is that they usually have low monthly payments and low interest rates. As mentioned, some monthly payments are just interest. In other cases, your monthly payment is the same as what it would be if you had a 30-year mortgage.
Lenders commonly determine monthly payments for a balloon mortgage the same way they do for a standard 30-year mortgage. So whether you get a 30-year conventional mortgage or a five-year balloon mortgage, your monthly payments could be the same. And since it’s a short-term loan, interest rates are usually below average. If you have an interest-only loan, your monthly payments will also be lower.
Of course, the low rates and low monthly payments don’t change the fact that you will have a large amount left to pay when your mortgage term ends.
If you’re trying to estimate your monthly payments, start with a free mortgage calculator. From there, you can decide whether a certain loan term and interest rate are right for you.
Since mortgage terms can vary so much, make sure to understand your specific mortgage agreement and what your monthly payments are before signing anything.
For most people, the answer is no. Even if you have an aggressive plan, like paying off your mortgage in five years, you should consider other types of mortgages. The final lump-sum payment simply isn’t feasible for most people.
However, there are some situations when a balloon mortgage may make sense for you. The most common is if you expect to receive a large payment before the end of the loan term. For example, you may expect a payment from a will or trust. People who flip houses may consider balloon mortgages because they anticipate the income from selling another property.
Getting a balloon mortgage and refinancing is also a legitimate strategy, but it’s very risky. A downturn in the market could leave lenders unwilling to give you a loan unless you have very good credit. A clear example of this is when the housing market crashed and lending requirements became more strict in the mid 2000s. Some people who took out a balloon mortgage around that time were unable to refinance. As a result, they had to go into foreclosure.
Policygenius’ editorial content is not written by a certified financial planner or advisor. It’s intended for informational purposes only and should not be considered legal, financial, or investment advice. Consult a professional to learn what financial products are right for you.
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