Advantages & Disadvantages of Balloon Mortgages

Balloon mortgages are short-term mortgages that “expand” at the end of the term to include the entire remaining loan balance. Basically, you can obtain a balloon mortgage with regular monthly payments at a fixed interest rate for a period of 1-10 years, and at the end of the term, you will be expected to pay off your mortgage in full. On a $100,000 balloon mortgage at 6.25% interest, for a period of 7 years, you would pay $615.72 per month. At the end of 7 years, your remaining mortgage balance would be $90,648.98 (considering you did not make any additional payments to your minimum monthly payment), which you would either have to pay out of pocket or obtain a new loan to pay off.

Advantages of Balloon Mortgages

Many people consider balloon mortgages when they know they are not going to live in the house forever. For example, if you know that after 7 years you will be moving and looking to purchase a new home, it makes complete sense for you to purchase your home using a balloon mortgage with a term of 7 years! Just as the term ends and you have to pay the remaining balance of the loan in full, you can sell the house. Interest rates on balloon mortgages are often lower than rates on the typical 30-year fixed rate mortgage. Where as many mortgages penalize you for making additional payments, a balloon mortgage does not charge pre-payment penalties, which means you can quickly reduce the principal amount of your loan just by sending an extra $100 or more each month with your payment. Balloon mortgages offer a lower monthly payment as they are amortized over a 30-year period rather than the shorter term of the balloon mortgage. This means you could qualify for a larger home than you would under a different type of mortgage option.

Disadvantages of Balloon Mortgages

Even though there are many advantages to choosing a balloon mortgage over a traditional mortgage option, there are also disadvantages to some individuals. Mainly, if there is reason to believe you will have difficulty refinancing the loan at the end of your fixed rate period (when the remaining loan balance is due), a balloon mortgage is probably not the right choice for you! If the market is predicted to have higher interest rates in five to seven years (or whatever the length of your balloon mortgage is), when you refinance the remaining balance of the loan you could end up with a much higher interest rate than you would have if you had just purchased the home using a more conventional mortgage option. Balloon mortgages sometimes cause people to buy a more expensive house than they can reasonably afford, because of the lower payments during the initial phase of a balloon mortgage. Once it becomes time to refinance the remaining balance at the end of the fixed rate term, some individuals find that they are unable to keep up with the higher monthly payments.

Converting Balloon Mortgages

Some mortgage lending institutions offer a conversion option of balloon mortgages. The conversion is often called a 5/25 Convertible, or a 7/23 Convertible loan, and when you are approved for the balloon mortgage you also set up what to do about the remaining principal loan balance at the end of the fixed rate period, guaranteeing the conversion based on predefined criteria- including making payments on time throughout the fixed rate period. This reduces some of the risk and worry that is often associated with balloon mortgages.