Balloon Mortgages generally feature lower interest rates, smaller monthly payments, and lower down payment requirements but the large balance that comes due at maturity may make them too risky for some homebuyers. The inability to pay the balloon payment due at the end of the mortgage term may result in foreclosure. Real estate lawyers warn that before taking this kind of loan, borrowers should understand the risk.
What is a Balloon Mortgage?
A balloon mortgage is a short-term loan, usually with a term of five to ten years. At the end of the term, the balance is payable in one lump sum, or balloon payment. Lower interest rates and monthly payments may make balloon mortgages attractive, but they are not right for everyone.
When is a Balloon Mortgage a Good Idea?
Buyers with access to the necessary cash to make the balloon payment may want to take advantage of the lower interest rates and monthly payments. Balloon mortgages may also be appropriate for those who will only be in the house for a short period before selling it, or investors who plan to “flip” the house quickly for a profit. The proceeds of such a sale are used to pay off the existing mortgage, eliminating the balloon payment.
Other buyers should be wary of balloon mortgage offers and consider other financing alternatives. Adjustable rate mortgages (ARMS) and FHA graduated payment home financing can help buyers secure their home and avoid the risk of not having the funds to make a balloon payment.
The Balloon Payment is Due, Now What?
In some cases, a real estate lawyer encounters a homeowner who already has a balloon mortgage and lacks the funds to make the balloon payment. In these cases, they may suggest:
- Loan modifications – The mortgage holder agrees to modify or convert the loan to a traditional fifteen or thirty-year mortgage
- Refinancing – The homeowner secures a conventional mortgage from another lender that will pay off the original balloon mortgage
- Home Equity Loans – If the home has enough equity, a home equity loan can provide the funds to make the balloon payment.
Understanding the Risks
The right mortgage can make homeownership come true. The wrong one can end in heartbreak, financial loss, and foreclosure. It is critical that homebuyers educate themselves about various mortgage types and select the one that best fits their situation.