A balloon payment on a mortgage is a large, one-time payment that is due at the end of the loan term. Mortgages with balloon payments are also referred to as balloon mortgages or balloon loans. This type of mortgage usually has a shorter term than a conventional mortgage, with lower monthly payments. However, the borrower must pay off the remaining balance in one big “balloon” payment at the end.
How Does a Balloon Mortgage Work?
With a balloon mortgage the monthly payments are calculated as if the loan had a longer amortization period usually 30 years. This means the payments are lower than they would be with a fully amortizing loan over the shorter mortgage term.
For example, you could take out a 10-year balloon mortgage that is amortized over 30 years. You would make lower monthly payments during the 10-year term as if it was a 30-year loan Then, at the end of the 10 years, you must pay the entire remaining principal balance as a balloon payment
Balloon mortgages may also have interest-only payments, where the monthly payments only cover the interest charges. The principal balance does not decrease over time with interest-only payments.
Features of a Balloon Mortgage
Here are some key features of balloon payment mortgages:
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Shorter term – Usually 5, 7 or 10 years compared to 15 or 30 years for conventional mortgages.
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Lower monthly payments – Payments are calculated based on a longer amortization schedule or interest-only.
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Large balloon payment – A big lump sum payment due at the end to pay off the remaining principal. Often twice the size of a normal monthly payment.
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Higher interest rate – Interest rates are typically 0.5 to 1% higher than conventional mortgage rates.
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Faster approval – May have quicker processing and fewer documentation requirements.
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Alternative lenders – Offered by private or portfolio lenders rather than banks.
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Risk of foreclosure – If the balloon payment cannot be made, the lender can foreclose.
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Difficulty refinancing – Borrowers may be unable to refinance if home values drop or credit scores decline.
When Does a Balloon Payment Become Due?
With most balloon mortgages, the large balloon payment becomes due at the end of the loan term, such as:
- 5 years for a 5/1 balloon mortgage
- 7 years for a 7/1 balloon mortgage
- 10 years for a 10/1 balloon mortgage
The number before the slash indicates the loan term and the number after indicates the amortization period. For example, a 10/1 means a 10-year term amortized over 1 year.
Some mortgages adjust annually rather than having one big payment at the end. But to qualify as a balloon, the final payment still has to be substantially larger.
Who Offers Balloon Mortgages?
Balloon mortgages are typically offered by small lenders, private lenders, or portfolio lenders. Large banks and mortgage lenders generally do not offer balloon home loans anymore.
Balloon mortgage lenders have more flexible qualifying requirements but charge higher interest rates and fees. They cater to borrowers who may not meet conventional mortgage standards but have plans to pay off the loan quickly.
Why Choose a Balloon Mortgage?
There are a few situations where a balloon mortgage could make sense:
- Only planning to stay in the home for 3-7 years
- Expecting to sell or refinance before the balloon payment
- Temporary reduction in income but expect an increase later
- Investors financing a flip project
It allows borrowers to get into a home sooner with lower payments. But the risks are high if you are unable to make the full balloon payment when due.
Alternatives to a Balloon Mortgage
Instead of a balloon mortgage, you could consider:
- Adjustable-rate mortgage – Payments start low but then adjust up gradually
- Construction loan – Single-close loan that converts to permanent financing
- Home equity loan – Second mortgage with fixed payments and term
- FHA loan programs – Low down payment options insured by the government
These alternatives let you start with lower payments but avoid a big lump sum due all at once.
How to Pay Off a Balloon Mortgage
When your balloon mortgage matures, you have three main options:
Pay off the balance – Ideally you saved up funds to pay the balloon payment in cash when due.
Refinance the loan – Take out a new mortgage to pay off the old one. You’ll need enough home equity and good credit.
Sell the home – Use the sale proceeds to pay off the balloon mortgage. But selling may be difficult if home values declined.
Otherwise, you would default on the balloon payment and the lender can foreclose on the home. So it is critical to plan ahead if you take out this type of mortgage.
Is a Balloon Mortgage Right for You?
While balloon mortgages allow lower payments at first, the risks are high. They are best suited for certain situations like a short-term home purchase.
To decide if it fits your needs, consider:
- How long you plan to stay in the home
- If you can make the balloon payment when due
- Your options for refinancing or selling the property
- Whether you can qualify for other mortgage programs
Carefully weigh the pros and cons before committing to a balloon mortgage. They offer flexibility but also come with the danger of foreclosure if not managed properly. Seek advice from a loan officer to review all your home financing options.
What Are the Risks to Lenders With a Balloon Mortgage?
A balloon mortgage has risks for lenders because the final payment is such a large amount. The odds are greater that the borrower won’t be able to make it and that the lender will have to foreclose on the property. Also, because the monthly payments are lower, lenders don’t benefit from a significant cash stream from the loan.
Sell the Home
Borrowers can use the proceeds of the sale to pay off the debt. Many people who choose balloon mortgages plan to be in that home for a few years. House flippers who buy, renovate, and sell residences may opt for balloon mortgages.
What is a Balloon Mortgage Loan? What’s the Benefit?
FAQ
Why would someone do a balloon mortgage?
A balloon mortgage offers low or no monthly payments initially, followed by a large lump-sum payment at the end of the loan term. Homebuyers might consider a balloon mortgage for several reasons, such as if they expect a significant income increase or plan to sell the property before the balloon payment is due.
Is balloon financing a good idea?
Balloon payments are not great for the every day buyer. Essentially deferring a one off large payment in the future on the hope that you will be disciplined and have the funds available when the time comes. Suggest having a higher loan payment (gonna need to save the money anyway) and forego the balloon.
Why do people avoid balloon mortgages?
Balloon payment: The balloon payment itself is a significant risk. Depending on how much you borrowed, the payment could cost hundreds of thousands of dollars. Some borrowers expect to refinance or sell the home before the payment comes due, but there’s no guarantee of either of those options.
Who benefits from a balloon payment?
Generally, loans have balloon payments to offset the lower amount of money that the borrower would put into a loan agreement. Placing a large, fixed sum final payment on the loan allows the lender to lower the interest rate and the monthly repayments while minimizing the lender’s long-term credit risk.
What is a balloon payment on a mortgage?
A balloon payment on a mortgage is a large, one-time payment at the end of the loan term. If you have a mortgage with a balloon payment, your payments may be lower in the years before the balloon payment is due, but you could owe a big amount at the end of your loan.
Should you get a balloon mortgage?
Balloon mortgages allow you to pay less to start with, but they carry significant risk. Balloon mortgages are short-term home loans that allow borrowers to make small monthly payments — or no payments at all — for several years. After that initial period is over, though, the remaining balance is due in one lump sum.
What is the difference between a balloon mortgage and a home loan?
Most home loans have steady and stable payments for the entire life of the mortgage, while balloon mortgages require you to come up with a substantial final payment that can sometimes be larger than the amount you initially borrowed.
What is an interest-only balloon mortgage?
An interest-only balloon mortgage means the borrower makes monthly payments only on the interest their loan is accruing. At the end of the loan term, they just have to pay back the principal. Borrowers tend to build equity on their house more slowly with this type of balloon mortgage.
What are the advantages of a balloon mortgage?
Some of their biggest advantages include: For many homeowners, balloon mortgages offer lower monthly payments than traditional fully amortized loans. That’s because many balloon mortgages are interest-only, and some don’t have any monthly payments at all.
How is a balloon mortgage structured?
Here are some ways it could be structured: Principal and interest payments: Although the balloon mortgage has a shorter term, your initial monthly payments will be calculated based on a typical 15-year or 30-year amortization schedule and include principal and interest.