A balloon mortgage is like a conventional fixed-rate mortgage in that it offers stable payments at a set interest rate over a specific number of years, but that’s where the similarity ends. Balloon mortgages don’t fully amortize, so there’s a large payment due at the end of the loan’s term. They’re not for everyone, but balloon mortgages are an ideal choice under certain circumstances.
How Does a Balloon Mortgage Work?
Even though balloon mortgages usually have a term of five or seven years, your loan payment and amortization schedule is the same as a 30-year fixed-rate mortgage. When you reach the end of the term, you must pay the bank a lump sum for the principal balance owed.
If you took out a conventional $200,000 mortgage over 30 years with a fixed interest rate of four percent, you would make 360 payments of $954.83 each and pay back the principal plus $143,739 at the end of the loan term. A similar balloon mortgage would start out the same way, but after making 60 payments when you’ve paid back $19,104.97 of the principal and $38,184.86 in interest, you would need to pay a lump sum to the lender in the amount of $180,895.03.
In a much-less-common variation of a balloon mortgage, you might see an interest-only period. The mortgage is amortized as a typical balloon mortgage over 30 years, but you would only pay the interest owed each month. At the end of the five or seven years, the entire principal becomes due.
Are Balloon Mortgages Allowable Under the New Mortgage Rules?
Balloon mortgages, especially interest-only balloon mortgages, were fairly common before the housing crisis. As those loans became due, many borrowers were unable to pay them off, and this contributed to collapse of the housing bubble. In 2014, the Consumer Financial Protection Bureau (CFPB) implemented a series of rules for lenders. Mortgages that meet its strict requirements are called qualified mortgages. The purpose of the CFPB’s requirements was to ensure that lenders make a good faith effort to ensure that borrowers have the means to repay loans before they originate them.
Interest-only loans are not allowed in qualified mortgages, but balloon loans are in certain instances. Balloon loans originated before January 10, 2016 may be considered qualified mortgages if they meet all of the other criteria and they are held in the portfolios of small lenders. The CFPB considers a lender small if it has less than $2 billion in assets and it originates no more than 500 first mortgages each year.
What Are the Advantages of a Balloon Mortgage?
When compared to other types of mortgages, balloon loans have a few advantages. They usually have a lower interest rate than other types of mortgages and they’re often easier to qualify for. Between the lower interest rate and the 30-year amortization, monthly payments are fairly low, especially in the case of an interest-only balloon mortgage.
Do Balloon Mortgages Have any Disadvantages or Risks?
If you’re only planning on staying in your home seven years or less, a balloon mortgage might be the right choice for you. There is the risk, however, that you cannot sell your home quickly enough to make the balloon payment or that the housing market in your area may decline taking your home’s value with it.
Even if you plan to stay in your home over the long-term, a balloon mortgage might be the right choice as most borrowers simply refinance the loan to make the balloon payment. Unfortunately, there’s always the risk that your financial situation has changed and you no longer qualify for the mortgage you need. The bottom line is that if you don’t have enough financial assets to pay the balloon when it’s due, a balloon mortgage is a definite risk.
Can I Refinance with the Same Lender When the Balloon Payment is Due?
Most balloon mortgage contracts have a clause that compels the lender to refinance your loan if you cannot make the balloon payment. While this might have you breathing a sigh of relief, it might not be best financial move. For example, when your balloon mortgage note is due, your lender will offer you refinancing at the financial institution’s going rate. You probably shopped around for the best rate when you took out the mortgage, and you should do the same at the end of your balloon note or you risk paying more than necessary. Also, since most of the terms of the refinance are already laid out when you take out the balloon mortgage, you have no recourse for negotiations as you would by going with a new lender for the refinance.
Refinancing with your current lender might be very valuable to you if your financial circumstance changes or if the general real estate lending sector tightens up its underwriting requirements. Your current lender is obligated to refinance your loan if it’s written into your contract even if other lenders won’t approve you for a mortgage.
How Does a Balloon Mortgage Compare to an Adjustable-Rate Mortgage?
Adjustable-rate mortgages (ARM) are similar to balloon mortgages in that it has stable payments and a fixed interest rate for three, five or seven years. Instead of a balloon payment coming due at that point, the lender adjusts the interest rate up or down to reflect the going rates. For borrowers who are able to pay off or refinance the loan when the lump sum payment is due, a balloon mortgage offers a few benefits. It’s much less complex than an ARM, and it generally comes with lower interest rates, which mean lower monthly payments for you.
ARMs, however, protect you from exploding interest rates. While ARM rates increase and decrease with the market, there are caps in place for each adjustment and over the life of the loan. If you’re refinancing a balloon payment, the entire loan will be subject to market rates. With an ARM, you’re also protected if your financial situation changes as long as you keep current on your payments, unlike balloon mortgages where you will need to refinance in five or seven years.
2 Point Highlight
If you’re only planning on staying in your home seven years or less, a balloon mortgage might be the right choice for you.
They’re not for everyone, but balloon mortgages are an ideal choice under certain circumstances.
