For people with globophobia, the thought of encountering a balloon, especially as it pops, can be terrifying. When you add in associations with horror movies and creepy clowns, balloons make some people downright nervous. Fortunately for aspiring homebuyers, balloon mortgages don’t involve rubber, helium, or spine-chilling jesters. Still, many prospective borrowers are wary of this type of mortgage. What is a balloon mortgage? If your lender floats the idea of this form of financing, should you consider it or run in the opposite direction?
What Is a Balloon Mortgage?
What is a balloon mortgage? It’s a mortgage with a somewhat unusual payment structure that culminates with one large payment at the end of the loan (source). This final payment is called the balloon payment or bullet. How does a balloon mortgage compare with more traditional mortgages?
To Amortize or Not
The majority of mortgages are amortized. An amortized loan is one that is paid off over a period of time in installments that are comprised of both principal and interest and equal to the total cost of the loan (source). When a set amortization schedule is followed, the loan is paid off when it reaches the end of its term. Balloon mortgages are not amortized. Instead, borrowers make smaller payments, if any, for an agreed-upon period of time before being required to pay a large lump sum to their lender.
Balloon Mortgage Advantages
Many people find the prospect of a large payment looming at the end of their loan unsettling, but balloon mortgages offer certain advantages that can help offset that discomfort. As Millionacres indicates, balloon mortgages generally come with lower interest rates. This means a smaller monthly mortgage payment. It also means that borrowers can often qualify for a bigger loan amount than they might otherwise be approved for if they opt for a balloon mortgage.
The Drawbacks of a Balloon Mortgage
The major drawback to a balloon mortgage is obvious: Borrowers must prepare for that large balloon payment at the loan’s end. Failure to do so could result in foreclosure. However, as The Balance points out, there are several strategies that borrowers can use to manage the balloon payment:
- Make the payment. If you have the resources, paying off the loan is an effective option.
- Refinance the loan. With good credit, you may be able to refinance and replace your balloon mortgage with a new mortgage before the balloon payment comes due. Refinancing typically pays off your old mortgage and allows you to start over with a new loan and new terms.
- Sell the home. What if you can’t afford the balloon payment, are uninterested in refinancing, or are ready to move on? Selling the home and using the proceeds to pay off the balloon mortgage clears the slate.
Who Might Benefit from a Balloon Mortgage?
Clearly, balloon mortgages aren’t right for everyone. However, there are borrowers who might benefit from using this form of financing. According to NerdWallet, a balloon mortgage can be a good choice in scenarios like the following:
- The borrower will sell the property before the balloon payment comes due. If you are completely confident that you will only be in the home for a few years and will sell it before the balloon payment is an issue, utilizing a balloon mortgage will let you take advantage of lower interest rates and smaller monthly payments during your stay in the home.
- The borrower will be receiving additional funds that exceed the value of the balloon payment before it comes due. Whether it’s an increase in income, an inheritance, or a series of bonuses, when you know that your financial resources will be getting a substantial boost in the future, opting for a balloon mortgage lets you get an earlier start on homeownership.
- The borrower will refinance before the balloon payment is due. Refinancing is a popular way to secure a better deal on your mortgage. If your financial situation has improved since your initial purchase, refinancing can be a smart move.
If you have questions about balloon mortgages or other home loan products, count on the friendly professionals at PrimeLending Twin Cities for clear, user-friendly answers. How can we help you achieve your housing goals? Contact us today to find out.