Balloon Mortgages

A balloon mortgage refers to a loan where the entire mortgage's principal amount is due at the end of a specified time period. Monthly mortgage payments are made for a number of years, usually well under the 15-year minimum used for most conventional, fixed rate mortgages.

What's the advantage of a balloon mortgage when buying a home? As you might have guessed, the interest rates for balloon mortgages are lower than those for fixed rate mortgages. Therefore, the monthly mortgage payments with a balloon mortgage will be lower than the monthly payments for conventional mortgages because of the lower interest rate.

OK, you're thinking, that's great while I'm making my monthly payments, but what happens when this huge amount comes due when the loan balloons? If you're thinking that while you'll probably be in better shape financially ten years down the road, you won't be in such good financial shape that you'll be able to pay off your mortgage, don't worry, you're far from alone. That's why most people who use a balloon mortgage to finance the purchase of their home, eventually refinance, meaning that they get a new mortgage and pay off the loan that has come due. Refinancing balloon mortgages is so common that some balloon mortgages have an attached option to refinance when the balloon payment is due.

When is a balloon mortgage the right choice? Is a balloon mortgage the right option for you if you're financing the purchase of a home? It might be if you fit certain criteria. If you don't plan on staying in your home beyond the balloon payment date, you will benefit from paying less due to your balloon mortgage's lower interest rate. This is a plus if you know housing dollars will be tight for a few years and especially if fixed rate mortgages are at high interest rates when you need a mortgage. If you're still in your home when the balloon payment is due, you could refinance for a more conventional mortgage and hopefully the interest rates have dropped and your income has gone up. You may be able to refinance on terms that are much more favorable to you at that point.

What's the downside? You will have to pay fees if you decide to refinance. That can be costly. You may or may not have to qualify for a mortgage all over again. This depends on the terms of your balloon mortgage as well as your individual situation. Of course, going through the qualifying process is not fun and no one wants to repeat it within a few years if they can help it. And last, but certainly not least, the interest rates could always be higher when you are refinancing than when you first got your balloon mortgage financing.

Tip A balloon mortgage can be a real money saver if you are relatively certain that you'll actually be able to pay off the balance of the mortgage when the balloon payment is due. For example, you might be a young couple or a single starting out and purchase a relatively inexpensive condominium or small starter house for your first home. Although your income probably won't be at its peak, if the home you purchase is not terribly expensive, you can start by taking advantage of the lower interest rates offered by a balloon mortgage to lower your monthly mortgage payment. Since you'll be making lower monthly mortgage payments, you can then set aside an amount each month and invest it as you see fit. If you plan carefully, by the time your balloon payment is due, say anywhere from five to ten years from the original date you took out your mortgage, your investment principal and its growth should make it possible for you to make that balloon payment, save a lot of money in interest and best of all, own your home outright.

© 2024 Wolters Kluwer. All Rights Reserved.