Balloon Mortgages: The Pros and Cons
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When it comes to mortgages, there are a lot of options to choose from. One popular option for home buyers is the . This type of mortgage offers a low-interest rate for a set period of time – usually 5, 7, or 10 years. After that period expires, the remaining balance on the mortgage becomes due and payable in one lump sum, known as a .
For many home buyers, a balloon mortgage can be an attractive option because it offers lower monthly payments during the initial stages of homeownership. However, buyers should be aware of some risks associated with this type of mortgage before signing on the dotted line.
What is a Balloon Mortgage and How Does it Work?
As we mentioned, a balloon mortgage is a home loan that requires a lump-sum payment at the end of the loan term. The monthly payments are typically lower than they would be with a traditional 30-year fixed-rate mortgage during the initial 5, 7, or 10-year period.
However, once that initial period expires, the borrower is responsible for paying off the entire remaining balance of the loan in one lump sum. For example, let’s say you take out a $100,000 balloon mortgage with a 30-year term. The monthly payments might be lower than they would be on a traditional 30-year fixed-rate mortgage, but at the end of the loan term, you would be responsible for paying off the entire $100,000 in one lump sum.
This can obviously be a difficult feat for many borrowers, which is why it’s important to have a plan in place before taking out a balloon mortgage. Borrowers should make sure they will have the financial resources available to make the lump-sum payment when it comes due.
Some balloon mortgages may give borrowers the option to refinance the loan before the balloon payment is due. This can provide some flexibility for borrowers who are worried about being able to make the lump-sum payment.
Types of Balloon Mortgages
There are three main types of balloon mortgages: balloon payment, interest-only payment, and no payment.
Balloon Payment
A balloon payment mortgage requires borrowers to make monthly payments for a set period of time – usually 5, 7, or 10 years. After that initial period expires, the remaining balance on the loan becomes due and payable in one lump sum.
Interest-Only Payment
With an interest-only payment balloon mortgage, borrowers are only required to make monthly interest payments for a set period of time – usually 5, 7, or 10 years. After that initial period expires, the remaining balance on the loan becomes due and payable in one lump sum.
No Payment
With a no payment balloon mortgage, borrowers are not required to make any monthly payments for a set period of time – usually 5, 7, or 10 years. After that initial period expires, the entire balance of the loan -principal plus interest – becomes due and payable in one lump sum.
Pros
There are both pros and cons to taking out a balloon mortgage. Here’s a look at some of the key advantages and disadvantages:
Easier to Afford the Initial Amount
As we mentioned, one of the biggest advantages of a balloon mortgage is the lower monthly payments during the initial stages of homeownership. This can free up some extra cash each month that can be used for other purposes – such as investing or saving for a rainy day.
Ideal for Those Who Expect Their Income to Rise
Another potential advantage of a balloon mortgage is that it can be a good option for borrowers who expect their income to increase in the future. This type of loan can provide some breathing room in the early years when incomes are typically lower.
Lower Interest Rates
Balloon mortgages often come with lower interest rates than traditional 30-year fixed-rate mortgages. This can save borrowers a considerable amount of money over the life of the loan.
Easier to Qualify
For some borrowers, it can be easier to qualify for a balloon mortgage than other types of loans. This is because the monthly payments are lower during the initial years of the loan term.
Refinancing Options
As we mentioned, some balloon mortgages offer borrowers the option to refinance the loan before the balloon payment is due. This can provide some flexibility for borrowers who are worried about being able to make the lump-sum payment.
Cons
Of course, there are also some potential drawbacks to taking out a balloon mortgage that borrowers should be aware of, including:
The Risk of Default
One of the biggest risks associated with a balloon mortgage is the possibility of default. This can occur if the borrower is unable to make the lump-sum payment when it comes due. If this happens, the borrower may lose their home to foreclosure.
This is why it’s important for borrowers to have a plan in place before taking out a balloon mortgage. Borrowers should make sure they will have the financial resources available to make the lump-sum payment when it comes due.
The Risk of an Adjustable Rate
Another potential risk associated with a balloon mortgage is that the interest rate may be adjustable. This means that the monthly payments could increase over time, which could make it more difficult to afford the loan.
This is why it’s important for borrowers to carefully read the terms of their balloon mortgage before signing on the dotted line. Borrowers should make sure they understand all of the risks and potential drawbacks associated with this type of loan.
Easier to Qualify
While it is often seen as an advantage, the fact that it can be easier to qualify for a balloon mortgage than other types of loans is also a potential disadvantage. This is because the lower monthly payments during the initial years of the loan term may not adequately cover the interest that is accruing on the loan.
This can put borrowers at risk of falling behind on their mortgage payments and ultimately losing their homes to foreclosure.
Liable for the Massive Final Payment
Even if you sell your home or refinance before the balloon payment is due, you may still be liable for the massive final payment. This is because many balloon mortgages have a “due-on-sale” clause, which requires the borrower to pay off the remaining balance of the loan if they sell their home.
This can make it difficult for borrowers to sell their homes if they need to move for any reason.
You May Not Be Able to Refinance
As we mentioned, some balloon mortgages offer borrowers the option to refinance the loan before the balloon payment is due. However, not all balloon mortgages have this option. And even if your loan does have this option, you may not be able to qualify for a new loan if your financial situation has changed.
This is why it’s important for borrowers to carefully consider all of their options before taking out a balloon mortgage. Borrowers should make sure they will be able to make the lump-sum payment when it comes due or that they will have the option to refinance the loan.
How to Pay Off a Balloon Mortgage
If you have a balloon mortgage, there are a few different ways that you can pay it off.
Refinancing
One option is to refinance the loan. This can be a good option if you have improved your credit score or financial situation since taking out the loan.
If you decide to refinance, make sure to compare offers from multiple lenders to get the best terms possible.
Making the Balloon Payment
Another option is to simply make the balloon payment when it’s due. This is only a good option if you have the financial resources available to do so.
Selling Your Home
If you need to move for any reason, you may be able to sell your home and use the proceeds to pay off the remaining balance of your loan. However, keep in mind that many balloon mortgages have a “due-on-sale” clause, which could make this difficult. Before you decide to sell your home, make sure to consult with your lender to see if it’s an option.
The Bottom Line
Balloon mortgages can be beneficial for borrowers who are able to make the lump-sum payment when it comes due. However, this type of loan also comes with a number of risks. Borrowers should make sure they understand all of the risks and potential drawbacks associated with a balloon mortgage before signing on the dotted line.
Balloon mortgages are not for everyone. If you’re considering a balloon mortgage, make sure to compare offers from multiple lenders to get the best terms possible. And be sure to consult with a financial advisor to make sure this type of loan is right for you.
