What Is a Balloon Mortgage?

If you’re thinking about purchasing a home, you should get familiar with your mortgage options. Balloon mortgages are not as common as traditional 15-year and 30-year mortgages. However, there are benefits of balloon mortgages that could make finding one a worthwhile endeavor. Here’s what you need to know about balloon mortgages and how to determine whether it’s right for you.

Understanding Balloon Mortgages

Balloon mortgages are a type of home loan with unique repayment terms. With these loans, the borrower makes small monthly payments for a defined period. The payments might go solely toward the interest of the loan, or they might be applied to both the interest and the principal. In some cases, the borrower won’t need to make any monthly payments. At the end of the initial repayment term, the borrower will be required to pay the remaining balance of the loan in one lump sum. This is known as the balloon payment. 

Types of Balloon Mortgages

There are a few ways that balloon mortgages can be structured. Each type of balloon mortgage has a repayment structure assigned to it. These are the types that you may come across if you’re considering a balloon mortgage. 

Balloon Payments

This type of balloon mortgage typically has initial monthly payments that are calculated based on a 15-year or 30-year amortization schedule. The payments might temporarily have a fixed rate which then increases later. At the end of the payment term, the remaining balance is due in full. 

Interest-Only Payments

Some balloon mortgages only require interest payments for the initial repayment period. At the end of that period, the remaining balance is due in a lump sum. 

No Payments

Another type of balloon mortgage doesn’t require any monthly payments for a short period. However, you still accrue interest during that time. At the end of the term, the principal balance and accrued interest are due. 

How Does a Balloon Mortgage Work?

Balloon mortgages use a payment structure called a nonstandard amortization. Amortization is how lenders calculate the monthly payments that will be required to fully pay off a loan during the loan term. The lender of a balloon mortgage might use an amortization schedule that is similar to a typical 15-year or 30-year mortgage. However, the monthly payments of a balloon mortgage will not be enough to cover the total loan cost over the loan term. 

Balloon mortgages typically have a shorter loan term between 5 and 10 years. At the end of the loan term, there will be a large outstanding balance that is due in full.

Here’s an example of how balloon mortgage payments might be structured:

• Mortgage Amount: $200,000
• Loan Term: seven years
• Interest Rate: 4.5%
• Monthly Payments: $1,013.37
• Balloon Payment: $175,066.06

When Does a Balloon Mortgage Make Sense?

• If you’re planning to renovate the home and then resell it for profit, also known as property flipping.
• If you’re only looking to own and use the property short-term and plan to resell it before the balloon payment is due. 
• If you already have money set aside to make the balloon payment but want to invest it elsewhere until the balloon payment is due. 
• If you’re expecting a significant increase in your income before the balloon payment will be due. 
• If you’re expecting to receive a large lump sum of cash from an inheritance, performance bonus or other source.

Pros and Cons of a Balloon Mortgage

Balloon mortgages can be a good option for many people, but they come with a certain amount of risk as well. It’s important to consider the pros and cons of a balloon mortgage to help you decide whether it’s the right option for you. 

Pros

• Balloon mortgages come with low initial payments.
• The low initial payments make it easier for people to purchase a home now, even if they haven’t been able to save up or move forward in their careers yet. 
• The turnaround time for balloon mortgages can be quicker than with traditional mortgages.
• There is usually no prepayment penalty, so borrowers have the option to make extra payments or pay off the mortgage entirely without being fined.

Cons

• It can be more difficult to find a lender who offers balloon mortgages.
• Balloon mortgages can be risky — if you can’t make the balloon payment, you’ll be at risk of losing your home and damaging your credit. 
• Due to the structure of balloon mortgages, it can take longer to build equity in your home, which can make it difficult to refinance when the balloon mortgage term ends.
• Interest rates can be higher than they might be with comparable traditional mortgages.

How to Pay Off a Balloon Mortgage

There are a few strategies you can use to pay off a balloon mortgage. 

Settle It

The simplest way to pay off a balloon mortgage is to settle it, meaning that you make the full balloon payment when it is due. This requires careful planning to ensure that you’ve set aside enough money throughout the loan term to pay off the loan at the end. 

Make Extra Payments

Another option is to make extra payments throughout the loan term. By making additional payments to pay down your loan principal, you’ll be left with a lower remaining balance at the end of the loan term. 

Refinance 

Instead of making the balloon payment, you might be able to refinance the loan. You’ll have to meet the lender’s requirements, including having enough equity in the home and proof of steady income. You’ll also need to consider how you’ll fit the payments of the new loan into your budget.

Sell the Home

If you’re planning to make renovations to the home, flip the home, or simply feel ready to move out, you can opt for selling the home. Then, you can use the proceeds from the sale to make your balloon payment.

Alternatives to Balloon Mortgages

Balloon mortgages can be a good option, but they are not the only option. Consider these alternatives to balloon mortgages to see which is best for your situation.

Adjustable-Rate Mortgages 

Adjustable-rate mortgages (ARM) are a traditional mortgage type. Unlike balloon mortgages, you repay this mortgage steadily throughout the loan term, and there is no large payment due at the end. ARMs start with a fixed interest rate and after the fixed-rate period ends, the mortgage is subject to interest rate changes based on the current market. This can be risky, as your interest rate and monthly payments will be unpredictable after the fixed-rate period ends.

Long-Term Mortgages

Some mortgages can come with longer terms than the standard 15-year or 30-year mortgage. It can be difficult to find and qualify for longer mortgage terms. However, if you do qualify, you can benefit from lower monthly payments because you are paying off the mortgage over a longer period. 

FHA Graduated Payment Mortgages

These mortgages are offered by the Federal Housing Administration (FHA) and provide some of the same benefits as balloon mortgages. There are lower monthly payments upfront, and then the payments gradually increase over time. The FHA has features built into these loans to protect borrowers and ensure that they will be able to afford the increased payments.  

Construction-to-Permanent Loans

These loans are designed for people who want to finance a newly constructed home. Typically, they come with interest-only payments while the home is under construction. After construction is finished, the loan is converted to a mortgage with monthly payments that cover both the principal and interest of the loan. 

How to Decide if a Balloon Mortgage Is Right For You

Balloon mortgages come with some attractive features, but you have to go into them with a plan to ensure that you’re able to make the balloon payment at the end of the term. If you’re considering a balloon mortgage, you should compare it with other mortgage options to see if it’s the best choice. You should also think about your goals for the home purchase and how you intend to make the balloon payment. 

Frequently Asked Questions