What is a balloon mortgage? According to The Motley Fool, it’s a mortgage that doesn’t fully amortize over the lifespan of the loan. Does that explanation leave you still asking the same question: What is a balloon mortgage? Don’t worry. Instead, keep reading for an explanation that’s a little more user-friendly.
Balloon Mortgage Defined
As Accounting Coach explains, when your lender fully amortizes a loan, they set up a schedule of regular monthly payments that results in the loan being fully repaid by the end of its term. The payments are divided between principal and interest. Initially, more of the payment tends to go toward interest, and the amount dedicated to paying down the principal rises over time until the final payment completely zeros out the debt so that the borrower owes nothing. While most mortgages follow an amortization schedule that provides for regular monthly payments, balloon mortgages have a different schedule.
The Balloon Mortgage Difference
Balloon mortgages come in a variety of shapes and sizes (source). Some have a fixed-rate format, while others are adjustable-rate loans. Some offer interest-only payments, while others have payments that include both interest and principal. The loan term is generally short, but there’s some variation there as well. The balloon loan’s defining feature is the balloon payment that comes at the end of the loan. Since the loan isn’t paid off in a series of regular payments before it comes due, the borrower still owes a substantial amount at the end of the loan. That amount is due in a final large payment, which is known as a balloon payment.
The Pros and Cons of a Balloon Mortgage
As NerdWallet reports, balloon mortgages have both pros and cons. These loans are appealing because they generally come with lower interest rates and lower monthly payments. Borrowers who expect their financial situation to improve significantly in the near future or who plan to sell their home before the balloon payment comes due are often tempted by these lower initial costs, but only borrowers willing to accept some serious risk should use a balloon loan. Borrowers who opt for these loans frequently have a plan for making the final payment or exiting the loan before it comes due, but even the best-laid plans can crumble. If the unexpected happens, and you’re unable to make the balloon payment, you could lose the property.
What Happens When the Balloon Payment Is Due?
When your loan has a traditional amortization schedule, you simply need to make your regular payments on time. If you opt for a balloon mortgage, you’ll need to have a plan for the final balloon payment. As The Balance explains, borrowers generally settle on one of three strategies:
- Pay off the loan. If you have the cash available, paying off the loan by making the balloon payment will bring the loan to a successful close.
- Refinance the loan. When you refinance, you pay off your existing loan by replacing it with a new one. Refinancing before the balloon payment comes due eliminates the need to come up with that much cash at one time, but you’ll need to be able to qualify for the new loan. To get a competitive interest rate and secure a loan with favorable terms, be sure to get your credit, income, and assets in good shape before you apply to refinance.
- Sell the home. Selling the home is another way to raise the funds to pay off a balloon loan. Unfortunately, there’s no guarantee that you’ll find a buyer who is eager to take the property off your hands quickly at the price that you want. If you plan to fund the balloon payment by selling the property, keep a watchful eye on your local real estate market and be sure to allow plenty of time to secure a sale.
While PrimeLending does not offer balloon mortgage products, we do offer conventional mortgages and mortgages from government-sponsored enterprises. The loan experts at PrimeLending of Kansas City would be happy to offer user-friendly guidance about home loans, their pros and cons, and how to choose the right loan product for your unique needs. Contact us today to discover how we can help you explore the possibilities.