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Balloon mortgages often have low rates and monthly payments, but only in the beginning — they pose a big risk for most homeowners.
When a balloon mortgage comes due, the borrower must pay a very large lump sum for the remaining balance
Most homeowners will not have a balloon payment on their mortgage
Balloon mortgages are most common for commercial real estate 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 shorter loan term, typically about five, seven, or 15 years, where some of the mortgage is still unpaid at the end of the term. At the end of the term, you make a large payment — “balloon payment” — to pay off the remaining loan balance.
Balloon mortgages are not common for regular homeowners, and some lenders won't even offer them. (Most qualified mortgages, QMs, cannot require the borrower to make a balloon payment except under narrow circumstances.) 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. Balloon mortgages usually have a low interest rate for most of the loan term, which may entice lower-income borrowers who are unprepared for the large balloon payment awaiting them at the end of the term.
Balloon loans are common 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.
A balloon mortgage is any mortgage that doesn’t undergo full amortization over the term of the loan, meaning that your usual mortgage payments won’t be enough to pay down the full balance. A large chunk of the mortgage will still need to be paid off at the end of the term. In return for putting off this large payment, balloon mortgages often have lower mortgage rates than conventional mortgages.
With a traditional fixed-rate mortgage or adjustable-rate mortgage, the loan will completely amortize by the end of the loan term, which means you’ll owe nothing.
But with a balloon mortgage, once the mortgage term ends, you will need to repay the outstanding balance with a lump-sum payment. This one-time payment, known as the “balloon payment,” will be significantly more than what your regular mortgage payments were. Balloon payment can be over tens or even hundreds of thousands of dollars. Selling the home and using the proceeds to repay the loan or refinancing are other options borrowers have when the balloon payment is due.
Balloon mortgages can vary quite a bit in structure. Some have a fixed 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.)
Regardless of structure, the enticing aspect of balloon mortgages is that they usually all have low monthly payments and low interest rates — certainly lower than your typical fixed-rate mortgage. 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. We'll talk about how much a balloon payment could be next.
Lenders commonly determine monthly payments for a balloon mortgage the same way they do for a standard 30-year mortgage. (They use the same amortization table.) So whether you get a 30-year conventional mortgage or a five-year balloon mortgage, your monthly payments could be the same. If you’re trying to estimate your monthly payments, start by using our free mortgage calculator.
Since a balloon mortgage is a short-term loan, the interest rates are usually below average. If you have an interest-only loan, your monthly payment could be even lower.
Of course, the low rates and low monthly payments don’t change the fact that you will have a very large amount left to pay when your balloon mortgage ends.
Since terms can vary so much, make sure to understand your specific mortgage agreement made with your lender 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 another type of mortgage. The final lump-sum balloon 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 sum of money before the end of the loan term. For example, you may expect a payment from a will or trust. People who work in real estate and flip houses may consider balloon mortgages because they anticipate money from selling another property.
Getting a balloon mortgage if you plan to refinance your loan before the final payment comes due is a legitimate strategy, but it’s very risky. A downturn in the market could leave a lender unwilling to extend you a new mortgage 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 their loans. As a result, they had to go into foreclosure when they couldn’t make the large balloon payment. Remember that refinancing means getting a new mortgage loan, so be prepared to undergo financial scrutiny once again.
You may also consider a balloon mortgage if you plan to sell your house before the loan term ends. However, there are no guarantees that you’ll be able to do so. Should you fail to find a buyer, you’ll be stuck with fronting the bill for the outstanding balance on your own.
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Derek is a tax expert at Policygenius in New York City. He has written about multiple personal finance topics in the past, and his work has been covered by Yahoo Finance, MSN, Business Insider and CNBC.
Policygenius’ editorial content is not written by an insurance agent. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.
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