Balloon mortgages are home loans that have a payment schedule based on long term repayment but have the entire balance due after a shorter period of time. As an example a seven year balloon mortgage would have payments based on a 30 year term length but the entire remaining balance will be due after seven years.
Taking out a balloon mortgage is a common way of getting lower mortgage rates and monthly payments than you could with a traditional 30 year fixed rate loan. Similar to an Adjustable Rate Mortgage, balloon mortgages shift much of the risk from the lender to you in exchange for a lower mortgage rate. The problem is that if you are unable to pay off the entire loan balance when the balloon payment is due or refinance you risk losing your home.
The risk associated with balloon loans and Adjustable Rate Mortgages is referred to as mortgage rate risk. This is the risk to the mortgage lender when giving you a rate without knowing what mortgage rates will be doing down the road. Lenders lose out on potential income by locking in your mortgage rate…Adjustable Rate Mortgages circumvent this risk by adjusting your payment amount should mortgage rates go up. Balloon payments reduce risk to the lender by requiring the loan be paid back in short periods of five to seven years. Because the balance of the loan is due with the balloon payment the lender can refinance at a higher mortgage rate.
If you are considering a mortgage with a balloon payment to get a lower interest rate you should consider how future mortgage rate increases could affect your monthly payments and your budget. Because most of your payment with balloon mortgage loans is applied to interest you will be building very little equity in your home; balloon mortgages should only be considered as a stopgap measure until more reasonable financing can be secured.
Many homeowners get themselves into trouble with declining home values when they find themselves upside down, owing more than their home is worth when the balloon payment is due. If you are upside down and owe a balloon payment it will be extremely difficult if not impossible to refinance or sell your home. Homeowners in this situation find themselves facing foreclosure…this is the risk you face when using a balloon mortgage loan.
You can learn more about your mortgage refinancing options including pitfalls to avoid like balloon mortgages and junk fees by registering for the free mortgage videos on this web site.
My name is Rob Regehr and I’m a personal finance writer with a chip on my shoulder for banks and brokers that take advantage of my friends and neighbors.
