A balloon mortgage is where you make low monthly payments for a short period of time, and then pay off the entire loan balance at the end of the term. Balloon mortgage terms are typically five to seven years, but can be as little as two years. The payments leading up to the final payment, which is known as the balloon payment, can be interest-only or a combination of principal and interest.
Note: SoFi does not offer balloon mortgages at this time.
The idea of low initial payments sounds enticing to many homebuyers, so let’s take a look at what exactly a balloon mortgage is and how it works, including pros and cons.
What Is a Balloon Mortgage?
A balloon mortgage is a mortgage with a shorter-than-normal term — maybe five or seven years as opposed to 15 or 30 — with relatively low monthly payments but a large lump sum due at the end of the term.
Typically, people who take out a balloon mortgage plan on selling the home or refinancing before the balloon payment is due. Some may expect to receive a large sum of money that can be used to pay off the loan.
Do Balloon Mortgages Still Exist?
Balloon mortgages do exist, although they are less common today than they were before the 2007-2008 financial crisis, which found many homeowners owing more on their loan than their property was worth. Balloon mortgages are not considered “qualified mortgages” — meaning they have an unusually high risk profile. Because they are higher risk, balloon mortgages may be offered only by smaller lenders.
Balloon mortgages are sometimes used for business loans, in which the founder wishes to have money to spend on launching the business and plans to repay it once the business is up and running and making a profit.
How Do Balloon Mortgages Work?
In technical terms, a balloon mortgage is one that hasn’t undergone full mortgage amortization. Although the payments are based on a 30-year term, the actual term is much shorter, which means a lot of money is left over at the end (hence the lump payment due).
Types of Balloon Mortgages
There are two ways a lender might calculate payments on a balloon mortgage:
Amortization Over a Longer Loan Term
In this scenario, the fixed loan payments may be based on a 30-year loan term even though the actual term is just 15 years. The borrower would make the relatively affordable lower payments for 15 years and then the loan balance would be due in a mortgage balloon payment.
Interest-Only Payments
Here, the borrower would pay only the interest on the loan for an initial period, and then the principal balance would be due in a balloon payment.
Balloon Mortgage Example
Below you can see how the two types of balloon mortgages might play out for a borrower who has a balloon mortgage for $300,000.
10-Year Balloon Loan at 6.50% With 30-Year Amortization
| Year | Monthly payment |
|---|---|
| 1 | $1,896 |
| 2 | $1,896 |
| 3 | $1,896 |
| 4 | $1,896 |
| 5 | $1,896 |
| 6 | $1,896 |
| 7 | $1,896 |
| 8 | $1,896 |
| 9 | $1,896 |
| 10 | $1,896 |
| Mortgage balloon payment | $254,328 |
5-Year Balloon Mortgage With Interest-Only Payments at 6.50%
| Year | Monthly payment |
|---|---|
| 1 | $1,625 |
| 2 | $1,625 |
| 3 | $1,625 |
| 4 | $1,625 |
| 5 | $1,625 |
| 6 | $1,625 |
| 7 | $1,625 |
| 8 | $1,625 |
| 9 | $1,625 |
| 10 | $1,625 |
| Mortgage balloon payment | $297,150 |
Why Would Anyone Want a Balloon Mortgage?
Being suddenly faced with a lump sum mortgage payment due might sound like a nightmare to most of us. So when would such a financial product actually be an attractive option?
It’s worth noting that balloon mortgages sometimes carry lower interest rates than 30-year fixed-interest mortgages, and in some cases, they can be easier to qualify for. That can make them tempting to those in the following situations:
• The borrower plans to sell the house and move before the balloon sum is due. This way, the lump sum is paid off with proceeds from selling the house — and in the meantime, the borrower benefits from the lower interest rate. This assumes, of course, that the home holds its value or increases in value in a relatively short time period.
• The borrower plans to refinance the loan once the balloon sum is due. This is a common scenario, and may give a borrower the opportunity to benefit from the lower interest rate of the balloon mortgage in the short term while buying time to build credit and shop for a better loan in the long term.
• The borrower expects to have the money to pay the balloon sum by the time it’s due. Maybe they have another property they plan to sell or are banking on an inheritance or some other savings plan — and they might save money in the long run on interest compared with taking out a traditional 30-year mortgage.
That said, there are obviously risks to this approach that may outweigh the benefits.
Recommended: Guide to Buying, Selling, and Updating Your Home
Pros and Cons of Balloon Mortgages
What are the specific advantages and disadvantages of balloon mortgages?
Pros of a Balloon Mortgage
• Possible lower interest rate. Balloon mortgages may carry a lower interest rate than mortgages with longer terms, depending on the lender’s criteria and the borrower’s creditworthiness.
• Possible lower monthly payment. Lower interest rates can translate to lower monthly payments, making the mortgage more affordable and easier to fit into the monthly budget (at least in the short term).
• May pay off the loan quicker. If a borrower is able to come up with the lump sum payment at the time it’s due, a balloon mortgage may allow a purchaser to pay off the house more quickly.
• Possibly easier to qualify for. Because of their lower payment, balloon mortgages may be easier for some consumers to qualify for.
Cons of a Balloon Mortgage
• Interest-only payments. In some cases, the monthly payments made during the term of a balloon mortgage may be interest-only — which means borrowers aren’t building equity in their homes during that time.
• Buyers may be unable to sell their house or refinance in time. To avoid the lump sum payment, borrowers must sell or refinance. If rates have risen or they can’t sell, they may face mortgage foreclosure.
• Buyer may pay more in fees. Even if successful, refinancing can incur fees that may mitigate some of the savings earned by taking out the balloon loan in the first place.
• Refinancing may increase monthly payment. After refinancing, monthly mortgage payments are often higher, especially if the balloon mortgage was interest-only.
• Risky for the borrower. Other unforeseen circumstances can wreak havoc on a balloon borrower’s plans, leaving them with a huge lump sum payment they can’t afford.
Other Types of Mortgages to Consider
Although balloon loans can be relatively easy to qualify for and do have some benefits, they can also be risky. We know what they say about best-laid plans — and even those with bulletproof plans sometimes encounter unforeseen circumstances.
What if the money that was set aside for the balloon payment has to be spent on a medical emergency or another surprise expense? What if the sale of the property or the annual bonuses fall through? What if, when it’s time to refinance, rates are actually higher or the borrower’s credit history is less favorable? What if property values have dropped precipitously and refinancing options are hard to come by?
Fortunately, there are plenty of other types of mortgages that can meet borrowers’ needs without creating an unduly risky scenario.
Fixed-Rate Mortgages
A fixed-rate mortgage, or FRM, is one in which the interest rate is fixed. The borrower pays the same interest rate over the entire term of the loan, usually 15 or 30 years.
The fixed interest rate also means the monthly payment amount is fixed, making this a popular type of mortgage for those who want to plan ahead to ensure that their mortgage payment will fit their budget.
FRMs protect buyers from rising interest rates; no matter what happens with the market, they can rest assured their rates will stay the same.
On the other hand, FRMs can preclude borrowers from benefiting when interest rates drop — which leads us to another popular type of mortgage.
Adjustable-Rate Mortgages
An adjustable-rate mortgage, or ARM, has an interest rate that fluctuates over the term of the loan based on the market. These loans generally begin with a relatively short period when the interest rate is fixed — known as the fixed-rate period — before switching to the variable interest rate.
ARMs are attractive for a variety of reasons. For one thing, the interest rate during the introductory fixed-rate period is often lower than it is in FRMs, meaning the borrower can enjoy smaller payments at the beginning of the mortgage.
ARMs may also allow borrowers to benefit when market rates drop. Though, if market rates increase, so can the borrower’s monthly payment. Some ARMs include clauses limiting the annual and life-of-loan adjustments and creating rate caps, which can help protect buyers, but it’s still not the same kind of peace of mind available from FRMs.
Recommended: Fixed vs. Adjustable Rate Mortgages: What’s the Difference?
More Ways to Find the Right Mortgage for Your Needs
Any mortgage — indeed, any loan — carries some degree of risk. But there are ways to mitigate the inherent hazards involved with owing a large debt. For one thing, figuring out how much house you can afford is an important first step to help ensure that you don’t overspend and end up with an unaffordable mortgage.
Once you’ve got a home-buying budget locked in, researching types of mortgage loans is a great next step. And finally, shopping around at different lenders for the best mortgage terms available can also help you save money in the long run.
Government-insured loans can help borrowers qualify with low-interest rates and down payments — as little as 3.5% for FHA loans (backed by the Federal Housing Administration) and even 0% for U.S. Department of Agriculture (USDA) loans in approved rural areas. But conventional loans, or those offered from private lenders, can also offer competitive terms and incentives.
The Takeaway
A borrower with a balloon mortgage makes low payments for, say, 5 or 7 years before a very large “balloon” payment is due to pay off the mortgage. Financing your home purchase this way can be riskier than other loan types, even though the upfront costs are enticingly low. Fortunately, there are other ways to borrow money for a home purchase that involve less risk.
FAQ
What is considered a balloon mortgage?
A balloon mortgage is one in which the borrower makes relatively low payments for an initial period of time (5, 7, or 15 years) before one very large mortgage “balloon” payment comes due.
Do balloon mortgages still exist?
Balloon mortgages do exist, although they are less commonly used for home purchases than they were in the past. Today they are used more often for commercial loans.
Why would you want a balloon mortgage?
Borrowers are attracted to balloon mortgages because of the period of low monthly payments at the outset of the loan term. They may plan to sell or refinance before the mortgage balloon payment comes due, or may think that they will come into other money — through an inheritance, for example — that will help them afford the balloon payment. However there is always risk involved in these scenarios.
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