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Balloon mortgages were far more common before the 2008-09 financial crisis. These days, most mortgages are 15- or 30-year loans with fixed interest rates. But balloon mortgages still exist.
In this article, we'll take a closer look at what a balloon mortgage is, how it works, and what home buyers need to know about the pros, cons, and dangers of these loans.
A balloon mortgage is a type of home loan that charges a lump-sum balloon payment at the end of the term.
To understand balloon mortgages, you need to know about loan amortization. This splits your mortgage loan into fixed monthly payments that cover the principal, interest, and other expenses over time. A more common loan type, called a fully-amortized loan, amortizes your balance over the entire loan term, so when you reach the end, you'll owe the bank nothing. This doesn't happen with a balloon mortgage.
With a balloon mortgage, the borrower will make payments for a certain amount of time. After this, the remaining principal balance is due in full with the final payment.
Balloon loans are used in several different types of financing, including a home purchase.
A balloon mortgage can work in several different ways, but you'll always have to make one big balloon payment at some point. Here are some ways balloon mortgages can be structured:
This is the most common type of balloon mortgage. Loan payments are calculated according to a normal 15- or 30-year amortization schedule. However, after a certain time period -- say five or seven years -- the remaining principal is due in one lump sum.
Let's say you're borrowing $200,000 to buy a home. You choose a balloon mortgage with a 3% interest rate, amortized over 30 years, with a balloon payment due after seven years. Your monthly mortgage payment would be $1,079 toward principal and interest, according to The Ascent's mortgage calculator. After the seven-year mortgage term, a principal balance of $167,561 would remain. And it would all be due at once.
You'll pay only interest on some balloon mortgages for the repayment period. This means borrowers pay only the monthly interest on the loan. The entire original principal balance is due at the end. This is most common in commercial real estate but isn't unheard of in the residential mortgage market.
There are also balloon mortgages with no monthly payments at all. These are usually short term (say, one-year). The interest that accumulates is then added to the final balloon payment. These balloon mortgages are often seen in fix-and-flip situations, where a year or two of interest is viewed as a part of a rehab project's cost.
Balloon mortgages carry more risk than other loan types, but there's usually a specific factor that appeals to borrowers. For example, a balloon loan might have a lower interest rate. Or, it could be an interest-only loan product. In either of these cases, the monthly payment could be lower.
Below is a rundown of the prominent features of other common mortgage types, compared to balloon mortgages.
The biggest risk of a balloon mortgage is what could happen at the end of the term. Unlike some of the other loan types, you'll owe a substantial amount of money all at once. If you can't pay it, you risk damaging your credit and potentially losing your home.
This depends on the specific loan. Seven-year balloon mortgages seem to be the most common, but you'll also find five-year and 10-year repayment terms. Balloon mortgages as short as three years, or as long as 30 years are possible as well.
In any case, the last payment of a balloon mortgage will be the lump sum of whatever principal and accrued interest is outstanding on the account.
In most cases, the borrower doesn't actually plan to make the balloon payment. Instead, the goal is to refinance the remaining balance or sell before the balloon payment comes due. This can be done by:
Balloon mortgages make the most sense for borrowers who only plan to own the home for a short period of time. This is especially true if you can find an interest-only balloon mortgage. Even then, balloon mortgages can be quite risky.
Some cases where balloon mortgages can make sense:
Always have a plan B in case your refinance options are less than ideal or more costly than the balloon payment you've been making. This might be in the form of a cash pad so you're financing less of the home’s value, or simply more room in your household budget for a much bigger payment.
Here are some other questions we've answered:
If you want to uncover more about the best mortgage lenders for low rates and fees, our experts have created a shortlist of the top mortgage companies. Some of our experts have even used these lenders themselves to cut their costs.
A balloon mortgage is a home loan with a balloon payment at the end of the term. The borrower makes agreed-upon payments for a certain amount of time, at the end of which a lump-sum payment is due.
This depends on the specific loan. Balloon mortgages can have repayment terms as short as three years or as long as 30 years. The most common lengths for balloon mortgages are five and seven years. During the repayment term, the borrower typically makes monthly payments, which may include principal and interest, or interest only.
For most borrowers, a balloon mortgage is a risky choice. It can make sense in cases where the borrower plans to sell the home or refinance their mortgage prior to the balloon payment. However, both of these scenarios involve significant risk that needs to be carefully considered.
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