Shopping for a mortgage is one of the first things you’ll do on your homebuying journey. Many buyers are aware that there are several types of mortgages available, including conventional loans and those backed by the federal government. But one option that most people aren’t aware of is a balloon mortgage. So what is a balloon mortgage, and could it be right for you? Let’s take a look.
What is a balloon mortgage?
A balloon mortgage is a type of loan that generally has a short term of five to seven years. After that term, the remainder of the loan must be paid in one lump sum, referred to as a “balloon payment”. Balloon mortgages often have low monthly payments, but are not typically appropriate for most buyers. The buyers who most frequently opt for a balloon mortgage are those who are planning to sell the home before the loan expires or those who have a plan in place for paying the lump sum.
How does it work?
Unlike traditional mortgages, balloon mortgages do not amortize during the life of the loan. With a typical mortgage, a buyer will make monthly payments over the life of the loan until it is paid off. But with a balloon mortgage, the monthly payments often stay the same until the term ends. At that time, the remaining balance must be paid in full.
What are the benefits of a balloon mortgage?
It may seem like a balloon mortgage isn’t a good choice for a home loan, but it does have advantages. First of all, balloon mortgages often have low interest rates. When your interest rate is lower, your monthly payments are lower. Secondly, the terms of the balloon mortgage are much shorter, which means you’ll pay less interest. Thirdly, you may be able to afford more house with lower interest rates and lower monthly payments. As we stated above, balloon mortgages can be viable options for those buyers who are planning to sell before the loan term expires, making it easy to pay off the remainder of the money borrowed.
What are the drawbacks of a balloon mortgage?
While there are certainly advantages to balloon mortgages, they do have drawbacks as well. Balloon mortgages can be risky for buyers because of that lump sum payment at the end. You’ll either need to sell or have a substantial amount of money saved up to pay off the loan. Balloon mortgages are also risky for lenders because of the risk of default. Another drawback is that even though a buyer may get a low interest rate for a balloon mortgage, they could get an even lower rate with a qualified mortgage like a FHA or VA loan. Balloon mortgages are also challenging to refinance because you’ll build up less home equity, making it more difficult to qualify.
Should you get a balloon mortgage?
In most cases, a balloon mortgage is not the best option for buyers. They come with a lot of risks and they can be difficult to find. But if you plan to sell quickly or know for sure that you’ll have the money to pay off the loan, then balloon mortgages can be an option to consider.