What are balloon loans?
Balloon loans are mortgage loans that come with a larger-than-usual payment at the conclusion of terms. In general, a balloon payment will be more than one and a half or two times the average monthly payment of the loan and, considering the large sizes of most mortgages, it can be up to tens of thousands of dollars.
Imagine holding a balloon for five minutes but on the final minute being ordered to inflate it. The deflated balloon was small up until the last minute when it massively increased in size.
As their name implies, balloon loans are mortgage loans that require borrowers to pay a large sum at the end of their loan’s term. That final payment is inflated, much like a blown up balloon, in order to completely satisfy the remaining balance.
Potential borrowers seeking mortgage loans in the form of balloon loans should be prepared to devise how they will be able to pay the final balloon payment once it is due.
Balloon loans typically have terms between three to ten years, but contrary to what one might expect out of a traditional mortgage, the payments are calculated as if the balloon loan has a lengthier term.
This, in effect, results in a relatively low monthly payment. Naturally, the entire principal is unable to be covered by
such low payments spread across such a short term. In order to make up for this, borrowers must pay off the remaining balance come their loan’s final payment.
Some balloon loans may be refinanced or even converted to a traditional mortgage loan, but those options are dependent upon the lending institution and the personal financial situation of the borrower.
With that in mind, if a borrower is expecting to come into a large amount of cash in the near future, such as from a legal settlement, inheritance or sale of valuable assets, then it may be advantageous to pursue a balloon loan in order to purchase a property with low payments until the necessary cash for the final balloon payment is acquired.
For all others, that final balloon payment should be carefully considered before agreeing to a balloon loan. Borrowers relying on their home’s equity must be aware that selling or refinancing their home may not be viable options to satisfy a balloon payment since future real estate values do not always increase, as we’ve seen with the recent housing market collapse.
Potential borrowers who can’t afford, or predict they won’t be able to afford, to pay off a balloon payment with their own savings would be better off considering a different or more traditional mortgage loan that may have easier payment options of more consistent amounts.