How Does a Balloon Mortgage Work?

Published on: October 23rd, 2019 | Written by Jimmy Vercellino

Balloon mortgages used to be one of the primary loan types used by people buying a home.

Although the practice of issuing these types of mortgages has recently become less popular, there are times when one could work to your advantage.

What Is a Balloon Mortgage?

A balloon mortgage is written to cover a shorter period of time than a typical home loan. In most cases, this ranges from 5 – 7 years.

During this time, you make payments on the loan. However, the payments are lower than those for a traditional loan. The terms of your balloon loan may have you paying only the interest on the loan.

This type of mortgage allows you to keep your payments low, but with the understanding that you will have one large payment at the end.

The opportunity to pay the remaining principal balance all at once can have benefits for people in certain situations. But it’s important to understand the potential challenges that can occur if you are unprepared for the end of your loan term.

What are the Pros and Cons?

The most obvious benefit of this type of loan is being able to keep your payments low. This arrangement is ideal when you know that you won’t be staying in the house for many years. People who move often for work sometimes use this balloon loans.

Buyers who are planning to fix up a house and resell it often prefer a balloon mortgage. Buyers may also benefit from this type of loan during a time when the interest rates are very high. By keeping the term short, they may be able to refinance for a lower rate at the end of the term.

The biggest drawback to a balloon mortgage is that it is risky if you are unsure about being able to make the final large payment. This often happens if your financial circumstances change, such as losing a high paying job.

You may also find it hard to make the payment if the home loses value, or if it does not sell fast enough to coincide with the end of the loan term. If interest rates continue to rise during the terms of your loan, then you may also be unable to secure lower rates when you try to refinance.

Can You Reset a Balloon Loan?

As with any type of loan, there are special circumstances that can apply. When you set up your loan, you may be able to establish that it can be reset at the end of its term. This will allow you to change to a better interest rate, or new amortization schedule, to continue to pay down the loan without having to make the final large payment.

What If You Can’t Make the Balloon Payment?

Smart financial planning means understanding every possible outcome. If you cannot make the balloon payment, you could be forced to default on the loan. You may also be tasked with the decision of selling your home when you were not planning to do so.

The majority of those who cannot make their balloon payment either sell their property or decide to refinance the loan. In either situation, you could still come out ahead if your home has increased in value, or if interest rates have gone down. Mortgage loan options are designed to help both borrowers and lenders work out agreements that benefit everyone.

A balloon mortgage is one option you have to obtain a loan to fit your specific situation and needs. This type of loan should never be entered into lightly. Professional advice should be sought before making a decision.

Our loan specialists are ready to help you understand your best option for purchasing your new home. This includes reviewing your situation regarding a balloon mortgage.

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