What Is A Balloon Mortgage?
This type of mortgage is referring to a mortgage that doesn’t amortize fully during the loan term. Moreover, the borrower will make set payments over time (five or seven years). At the end of the loan term, all of the remaining balance is due at once. As you already know, the payment has the potential to be huge. That’s why we call this a “balloon payment.”
You calculate balloon loans by amortizing the loan over a 30-year period. Moreover, there are other ways to calculate, such as interest only. Some balloon loan options also have a reset option that’s available towards the end of the loan. This will automatically recalculate the mortgage at the then-current interest rate. If there is no option, this means that a buyer has plans to refinance or sell their property before the loan-term ends.
Balloon Mortgage – Example
Here’s an example. If you are purchasing a balloon mortgage that’s seven years to obtain property, you have seven years monthly, equal payments at a fixed rate. This rate is lower than the rate a person gets on an ordinary mortgage loan. When the seven years are complete, the balloon payment on the remaining balance is due. Furthermore, the borrower has the following options: refinance with the same lender or different lender, sell the home, or pay the remaining balance in full.
Let’s say for instance you are taking out a balloon loan of an amount $200,000 that has a 7 term with a 4.5%interest rate amortized over 30 years. Since you are not paying off your loan for the full 30 years and making payments for five years, you’d owe $186,213.13 after you pay 84 months worth of payments. In addition to, you have to pay rest of the payment all at once.
How Does a Balloon Mortgage Compare With Other Mortgage Types?
To show you how balloon mortgages compare to other mortgages, let's say that you need to borrow a $200,000 loan to buy a home. Below is information on the details of payments of what a buyer can expect with a balloon mortgage. The table also shows the above scenario with a 30 or 15 year fixed-rate home loans along with an adjustable rate mortgage.
|Mortgage type||Typical interest rate||Initial monthly payment||Total of monthly payments||Remaining balance after loan term||Total cost of loan|
|30-year fixed||5.45%||$1,110||$ 399,818||$0||$ 399,818|
|15-year adjustable||4.55%||$ 1,535.10||$ $284,888||$0||$ $284,888|
|5/1 adjustable (ARM)||4.4%||$1001||uncertain||$0||uncertain|
From the example above, one can see that balloon mortgages have lower interest rates. As a result, the monthly payments are lower with this type of loan without the need to worry about an adjustable interest rate. Moreover, the average borrower is able to qualify for higher loan amounts with a balloon mortgage than other types of loans.
Overall, balloon mortgages are great for those who expect their income to rise in the year to come and/or those who have the possibility of having a credit score increase down the road. This type of mortgage is also good for people who want to sell their property before their long-term is up. A balloon loan will also provide the lowest interest possible in the meantime.
Balloon Mortgage Pros and Cons
Getting a balloon mortgage is a great option for those who want a low, fixed-interest rate. With this mortgage, you have a shorter term (shorter than other types of loans) lasting only 5 to 7 years. On the other hand, obtaining this type of loan will leave you paying a huge lump sum of money t the end of the loan term.
The lender requires that amount to be paid in full. A balloon loan is great for individuals who are expecting a raise or higher income in the next few years or so. People who also plan to not stay in their home in the next few years can benefit from having this type of loan as well. I will mention the advantages and disadvantages of a balloon mortgage loan.
Affordable Initial Cash Outlay
This loan offers a low down payment, which makes it very appealing to people. As a result, this allows plenty of people to qualify to purchase a house with this type of mortgage. If you don’t have a lot of money right now and expect to receive an abundance of cash within 5 to 7 years, this is a great option for you.
Amortized over 30 years
This means that your payments are lower because you’re as if you have a 30-year loan term. If you know for certain you are able to refinance, pay the balloon payment or sell the hours before the balloon is due. As a result, you have the opportunity to benefit greatly from the reduced payments.
Low-interest rate means that your payments are smaller. This is really great if you are buying a house since the amount of interest you pay comes out of your profit.
If you decide to keep your house, your payments need to be as low as possible before the balloon is due for payment. You also have the option to refinance in this case.
Easier to qualify
If you need a loan now, balloon loans are easier to qualify for than traditional loans. This means that you are able to get a house at a faster rate. If you have the assurance that you can refinance or expect to receive a lump sum of money (increase in income), a balloon loan is a great opportunity for you.
Remaining Balances Can Be Refinanced
If people aren’t able to repay their loan at the end of the mortgage term, they have the option to reapply for a resetting of their loan balance. The interest rate that lenders use to refinance the loan will be the prevailing market rate.
In other words, this means that a borrower will pay an interest rate that is higher than the previous one.
Higher Risk of Foreclosure
Even though there is always a risk of foreclosure with having a home loan, balloon loans put you at an even higher risk. Aside from having to pay a big amount all at once, not being able to refinance your loan increases the chance of foreclosure making the situation even more difficult to handle.
Because either people couldn’t pay off their balloon loans off on time, sell their home fast enough, nor get a refinance, a lot of people faced foreclosure during the 2008 mortgage crisis.
Easier to qualify
If you aren’t confident that you can afford taking out a balloon loan, don’t do it; it can be a nuisance for you in the long run. Even though you have the opportunity to get a balloon loan, it doesn’t make it right for you to take it.
In addition to, selling it at loss of profits and foreclosure are the consequences of not meeting the lender’s payment expectations. If you don’t have the option to refinance, you can hope to sell at a gain and take it as a lesson learned. Keep in mind that you will lose your home at the same time.
Large Payment Due Upon Maturity
Having to pay a large amount of money at the loan’s maturity is the biggest drawback of a balloon loan. If you ever consider getting this type of loan, make sure you are financially stable to make such a payment at the end of the loan term because the amount you have to pay has the potential to be a huge expense. An average family may not be able to raise the money within 5 to 7 years pay off the balloon loan.
Overall, you take a higher risk with balloon loans than you would with a tradition loan. If you’re able to keep your housing costs low and you get out of the balloon payment before it's due, this loan may be a good choice for you. On the flipside, if you’re finances aren’t secure and you’re not confident that you can handle a balloon loan, then a traditional loan is the better option for you.
When you are considering purchasing a home, delegating what to do next hinge on what is your end goal and how you plan on dealing with the loan. If you expect a significant increase in your income, and your credit score is excellent and spotless, a balloon loan may be a good option for you.
Take into account your current circumstances, finances, and financial potential for the future before you move forward, your lender of choice will guide you into choosing the best option for your situation and give you the advantages and disadvantages of a balloon mortgage.