What Is a Balloon Mortgage?
A balloon mortgage is a real estate loan with an initial period of low or no monthly payments. The borrower pays off the full balance in a lump sum at the end of the term. The monthly payments, if any, may be interest only, and the interest rate is commonly low.
Key Takeaways
- A balloon mortgage is a real estate loan with an initial period of low or no monthly payments.
- A balloon mortgage is usually short-term.
- The borrower pays off the full balance in a lump sum at the end of the term.
How Balloon Mortgages Work
Balloon mortgages can be structured with varying terms and maturities and may have fixed or variable interest rates. Some short-term loans may require the borrower to make the principaland interest repayments at maturity with no amortization over the life of the loan.
Balloon mortgages can also charge interest-only payments, allowing borrowers to make low monthly payments before repaying the lump sum when it is due. In one variation on the balloon mortgage, called the balloon payment mortgage, the borrower pays a set interest rate for a certain number of years. The loan will reset with the balloon payment rolling into a new or continuing amortized mortgage at the prevailing market rates at the end of that term.
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Pros & Cons of Balloon Mortgages
Pros
Low payments for homeowners who plan to stay in the home for a short period
Low payments prior to a refinance strategy when lower future interest rates are anticipated
Payment strategy for homeowners who are paid in lump sum bonuses to pay off the balance
Cons
Slow or no equity building with a balloon mortgage when interest-only payments are made
Difficulty in changing terms of loan or refinancing the mortgage
Long-term risk if homeowner is unable to accumulate and save lump sum payment
Examples of a Balloon Payment Schedule
A homebuyer may take a seven-year balloon mortgage of $150,000, paying $531.25 in interest-only payments each month. Throughout the life of the loan, those payments wouldn’t change, but neither would the balance due on the mortgage. At the end of the term, the buyer owes $150,000.
A balloon loan of $300,000, with a longer term of 17 years and a buyer paying both interest and principal each month, would look like the below, with a balloon payment of $35,000 due at the end of the term.
| Payments on a $300,000 Balloon Loan | ||||
|---|---|---|---|---|
| Month | Payment | Interest | Principal | Balance |
| 1 | $2,028.57 | $1,062.50 | $966.07 | $299,033.93 |
| 2 | $2,028.57 | $1,059.08 | $969.49 | $298,064.44 |
| 3 | $2,028.57 | $1,055.64 | $972.92 | $297,091.52 |
| 4 | $2,028.57 | $1,052.20 | $976.37 | $296,115.15 |
| 5 | $2,028.57 | $1,048.74 | $979.83 | $295,135.33 |
| 6 | $2,028.57 | $1,045.27 | $983.30 | $294,152.03 |
| 7 | $2,028.57 | $1,041.79 | $986.78 | $293,165.25 |
| 8 | $2,028.57 | $1,038.29 | $990.27 | $292,174.98 |
| 9 | $2,028.57 | $1,034.79 | $993.78 | $291,181.20 |
| 10 | $2,028.57 | $1,031.27 | $997.30 | $290,183.90 |
| 11 | $2,028.57 | $1,027.73 | $1,000.83 | $289,183.07 |
| 12 | $2,028.57 | $1,024.19 | $1,004.38 | $288,178.69 |
| 183 | $2,028.57 | $190.12 | $1,838.45 | $51,841.83 |
| 184 | $2,028.57 | $183.61 | $1,844.96 | $49,996.87 |
| 185 | $2,028.57 | $177.07 | $1,851.49 | $48,145.38 |
| 186 | $2,028.57 | $170.51 | $1,858.05 | $46,287.32 |
| 187 | $2,028.57 | $163.93 | $1,864.63 | $44,422.69 |
| 188 | $2,028.57 | $157.33 | $1,871.24 | $42,551.45 |
| 189 | $2,028.57 | $150.70 | $1,877.86 | $40,673.59 |
| 190 | $2,028.57 | $144.05 | $1,884.51 | $38,789.08 |
| 191 | $2,028.57 | $137.38 | $1,891.19 | $36,897.89 |
| 192 | $2,028.57 | $130.68 | $1,897.89 | $35,000.00 |
Defaulting on a balloon mortgage has serious consequences: The home may be foreclosed upon, and the borrower’s credit score will suffer a major hit.
Paying Off a Balloon Mortgage
Borrowers generally have three options when it comes to paying off a balloon mortgage.
Settle It
Borrowers can pay the remaining principal in full. Ideally, borrowers plan through saving and investing with this short-term time frame in mind, or their income has risen by the end of the loan term.
Refinance It
Borrowers can pay off one mortgage by taking out another loan, commonly a more conventional fixed-rate mortgagethat amortizes over its term. This strategy works if borrowers have built up a steady amount of equity in the home, have a steady income or other assets, and have a good credit history.
Sell the Home
Borrowers can use the proceeds of the sale to pay off the debt. Many people who choose balloon mortgages plan to be in that home for a few years. House flippers who buy, renovate, and sell residences may opt for balloon mortgages.
What Are the Risks to Lenders With a Balloon Mortgage?
A balloon mortgage has risks for lenders because the final payment is such a large amount. The odds are greater that the borrower won’t be able to make it and that the lender will have to foreclose on the property. Also, because the monthly payments are lower, lenders don’t benefit from a significant cash stream from the loan.
Why Would Someone Choose a Balloon Mortgage?
People who expect to stay in their home for only a short period may opt for a balloon mortgage. Others may intend to stay in their homes and refinance before the balloon payment is due.
How Do Businesses Benefit From a Balloon Mortgage?
The balloon mortgage is used by businesses in the construction industry to obtain short-term financing for construction projects without offering collateral. In this case, they are generally short-term loans with higher interest rates than conventional collateralized business loans.
The Bottom Line
A balloon mortgage is a home loan with an initial period of low or interest-only payments. The borrower pays off the balance in full at the end of the term. A balloon mortgage is usually short-term, often five to seven years. Balloon mortgages can be advantageous to buyers planning to be in the home for a short period and are often used for commercial real estate.
