Photo Courtesy of Simon Bratt/Shutterstock
Balloon mortgages are not uncommon when purchasing a single-family home, but here’s what you need to know about the nontraditional route.
There are many types of mortgages; however, a balloon mortgage isn’t even one of the most common ones. Some people might find that it’s their only real option though, so it might be worth looking into all possibilities. A balloon mortgage, a non-qualified mortgage (non-QM) loan, allows the homebuyer to have lower monthly payments, but eventually, they’ll have to pay the remaining balance off. Again, it’s not a regular route, so as always, look at your personal financial situation to determine if it’s worth pursuing. So, what is a balloon mortgage exactly? Here’s what you need to know about the nontraditional loan.
What is a Balloon Mortgage?
Most people have a 30-year mortgage. With a balloon mortgage though, that time is compacted into, usually, five to seven years. The monthly payments are lower and possibly nonexistent. The interest rates could be lower or higher when compared to traditional mortgages depending on the circumstances. However, at the end of the term, the homebuyer must pay off the remaining balance. Like a balloon, the small payments expand at the very end.
“People buying single-family residences to live are not likely going to encounter balloon mortgages. Typically, these loans are associated with investments and or hard money financing,” says Matt Schwartz, mortgage broker at VA Loan Network.
Pros
- Lower monthly payments
- Potentially lower interest rates
Cons
- Lump sum due at the end of term
- Not offered by many mortgage lenders
- Risky for homebuyer
How Does a Balloon Mortgage Work?
You’ll enjoy your low monthly mortgage payments for five to seven years. But then, there will be a “balloon” payment at the very end and the remaining balance is due. Although you’re expected to pay that amount, some owners opt to refinance or sell the property when the time comes to avoid that payment.
“One thing I always emphasize with balloon mortgages is that they require a level of planning and financial discipline that not every borrower is prepared for – and that’s OK. These loans are designed for very specific situations, not broad appeal,” says Estela Nagahashi, interim CEO at University Credit Union (CA).
Who is a Balloon Mortgage Best For?
A balloon mortgage is quite specific, so it doesn’t make sense for most borrowers. Someone who is extremely confident in their finances and has a solid plan for that “balloon” payment at the end would be the best candidate.
“It could work for someone who expects a significant increase in income or has other financial resources they plan to tap into later, like selling another property, receiving a large bonus or accessing funds from an investment. The key is that they need to be absolutely sure those funds will be available when the time comes,” says Nagahashi.
Who Should Avoid a Balloon Mortgage?
One of the benefits of a traditional fixed-rate loan is that you know what to expect with your payments. However, that super payment at the end of a balloon mortgage can hit harder than you realize. So, someone who wants that long-term stability or has no firm grasp on future finances should avoid this type of mortgage.
“It’s not a great option for anyone who’s unsure about their ability to refinance later. Life happens – your credit score could take a hit, interest rates could rise or the housing market could cool off, making it harder to refinance or sell,” says Nagahashi. “If your entire plan depends on something going right in the future and there’s no backup plan, that’s a red flag.”
The Bottom Line
There’s a reason that you might not have heard the term “balloon mortgage” earlier. It’s not a common route when seeking homeownership; however, for the right person it could be a viable option. As with any type of mortgage you’re signing on the dotted line for, be certain that you’ll be able to meet your obligations, which in this case is paying that lump sum when the time comes. After all, your financial health could depend on it.
Why You Should Trust Us
Benzinga has built up a readership of around 25 million visitors per month and that’s in large part due to our thorough examination of a range of financial topics. We’ve made it our mission to help readers of all different backgrounds understand their options regarding mortgages. While it typically comes down to your situation, we explain what you need to know to make smart decisions.
Caitlyn Fitzpatrick, the author of this article, has been an editor and writer since 2014. She has years of experience researching complex topics and interviewing experts to provide you with easy-to-digest information. To gather real-world insight, we talked with Matt Schwartz, mortgage broker at VA Loan Network, and Estela Nagahashi, interim CEO at University Credit Union (CA), to understand the pros and cons of this specific mortgage loan.
FAQ
A
The big disadvantage of a balloon mortgage is that things could happen within five to seven years, impacting your ability to pay the lump sum at the end of the term. Life events happen, employment status could change and where you were at the beginning could change by the end. It’s a risky move for the homeowner, so they should feel confident going into it.
A
“It depends on the terms of the loan. Oftentimes, you can pay the balloon off early; however, there may be a prepayment penalty associated with doing so,” says Schwartz. Before committing to a balloon loan, ensure you know what your lender does and doesn’t allow.
A
Schwartz explains that this is a mortgage that, for payment purposes, is amortized over 30 years but becomes due in full in five years. So, the monthly payments are based on if they were spread over 30 years, but your term is five years.
Sources
