Balloon Payment Mortgage
To begin with, it may be helpful if we clarify the meaning of the term ‘balloon payment’. A balloon payment is a large one off payment at the end of your mortgage term, also known as ‘maturity date’.
Balloon loans are fixed rate loans with low monthly payments supplemented by a large payment every three, five, seven, 10, or 15 years. The vast majority of balloon loans are for 30-year mortgages, which will have two or more balloon payments over the course of the mortgage. More...
Balloon Loan Advantages
Balloon loan interest rates are usually lower than ARM of fixed rate mortgages rates, making monthly payments more affordable. Also, most balloon loans can also be converted to a fixed rate loan after the first balloon payment.
If you refinance the loan at maturity you need not be ‘requalified’. The interest rate on the new loan will be in line with market rates but some lenders will charge a modest fee for conversion.
Balloon Loan Disadvantages
While monthly payments are set at a low interest rate, the balloon payments are often substantial. As mentioned previously, balloon payments come around every three to 15 years so there is always a need to find a lump sum – which can be stressful. Some people refinance to pay balloon payments, while others dig deep into their savings or investment funds.
Unsurprisingly then, some balloon loans come with refinancing options to allow borrowers to convert to a fixed rate loan after the balloon payment. The fixed rate loan is then calculated based on the outstanding principal balance and is only possible if borrowers meet certain conditions. The conditions depend on the lender and the individual circumstances of each borrower.
Balloon Loan Risk Factor
Balloon loans are not for the feint hearted or for people who have limited disposable income. When a balloon payment is due, the mortgage loan must be paid in full. If you are not eligible for refinancing onto an alternative mortgage and lack adequate savings, you may be forced into foreclosure.
Balloon Loan v Adjustable Rate Mortgage
Balloon loans are risky business compared to ARMs. A three-year ARM will have an adjustment after three years and yes subsequent interest rates may be high. With a three-year balloon loan, however, the full loan will be due at the end of the three-year period – making balloons the riskiest of the two mortgage plans.
If however, you are confident you can refinance at the end of the balloon term and are prepared for higher interest rates – a balloon loan may be for you.
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