Balloon mortgages are often referred to as “reset mortgages,” these loans lure homeowners with very low interest rates and 5 to 7 years to repay. These mortgages carry a significant amount of risk for the borrower. Here is what you need to know to minimize the risks with these mortgages.
Repayment of this mortgage is based on a 30 year repayment schedule; however, the borrower only makes payments for five to seven years. This allows the borrower to make low payments for the duration of the loan. At the end of the loan period the balloon payment for the remaining balance is due; some lenders allow you to refinance at the end of this period for a fee.
Balloon mortgages allow the borrower to qualify for a much larger loan amount than they could with a traditional mortgage; when abused these mortgages have the potential to ruin the finances of the unsuspecting homeowner.
Balloon mortgages are designated by the lender using a numbering system. The loan can be represented a 7/23 loan. This means the borrower has seven years before the balloon payment becomes due; the balloon payment represents 23 years of principal. If you add these two numbers together you will get the amortization schedule, which is thirty years.
The lender may allow you to automatically reset the mortgage when the balloon payment is due. The lender may require that you have made all of your mortgage payments on time to qualify for the reset. If you do not qualify for the reset with your current mortgage lender you can still refinance through another mortgage lender.
Balloon mortgages do not come with caps to prevent large changes in the interest rate or monthly payment amount. This makes them significantly more risky than a standard Adjustable Rate Mortgage. If you are unable to pay off the balloon payment when it is due and cannot qualify to refinance the mortgage the lender will foreclose and take your home. To learn more about finding the best mortgage while avoiding common mortgage mistakes, register for our free mortgage guidebook.