A “balloon mortgage” is a home loan that does not fully amortize over the life of the loan, leaving a balance at the end of the term.
As a result, the final payment on a balloon mortgage is significantly larger than the regular monthly mortgage payments .
Of course, most borrowers expect to either refinance before the balloon mortgage term ends, or sell the associated property.
Let’s look at a quick example:
7-Year Balloon Mortgage
Interest Rate: 5.00%
Amortization: 30 Years
Loan Amount: $250,000
In the above scenario, the monthly mortgage payment would be $1342.05 per month for the first seven years, with a remaining balance of $221,204.98.
The remaining balance is the balloon mortgage payment that is due in full after seven years. It probably sounds like a lot of money to pay (it is!), but as mentioned earlier, most borrowers either refinance or sell before it gets to that point.
The ING Easy Orange Mortgage is an example of a balloon payment mortgage.
Seconds mortgages may also be balloon mortgages, a common one being the “30 due in 15.” It amortizes like a 30-year mortgage, but full repayment is due in just 15 years. Again, most borrowers either pay it off, refinance, or sell before the term ends.
Advantages of Balloon Mortgages
You may be wondering why a homeowner would choose a balloon mortgage as a opposed to an adjustable-rate mortgage or a fixed-rate mortgage .
Well, balloon mortgages rates should come at a discount to fixed-rate loan and ARM rates, making them a cheaper alternative.
And if you don’t plan on staying
in the home or with the loan for more than a few years, it could prove to be the right choice for you.
Of course, the big tradeoff is the associated risk.
Disadvantages of Balloon Mortgages
The clear disadvantage to a balloon mortgage is the uncertainty at the end of the loan term.
For example, after seven years, the entire loan balance is due.
Imagine if your home falls in value and you owe more than the final balloon payment – you’d have a major problem assuming you couldn’t execute a short sale or refinance.
This isn’t the case with a fixed-rate loan or an ARM.
Fixed-rate mortgages have the same payment throughout the life of the loan, while ARMs may adjust higher or lower, as determined by their caps. Those caps will limit the amount the mortgage payment can rise, providing some level of protection.
Sure you could be underwater on your loan (owe more on mortgage than home is worth), but the payments would likely stay manageable thanks to the caps.
Balloon Mortgage vs Adjustable-Rate Mortgage
A balloon mortgage differs from an adjustable-rate mortgage because full payment is required at the end of the loan term.
With ARMs, the loan simply becomes adjustable after the fixed-rate period, but isn’t due in full immediately.
It continues to amortize on a 30-year schedule, though mortgage payments can fluctuate based on the variable interest rate.
In conclusion, be sure to compare all your options – you may be surprised to find that a fixed-rate loan prices better than an ARM or a balloon mortgage, without all that risk!