What is Balloon Mortgage?
When you talk or read about the different types of mortgages, you may have heard the term “Balloon Mortgage” and wondered exactly what it meant. You may have wondered how a mortgage and a balloon are alike and why anyone would want that type of mortgage.
Also known as balloon payment mortgage, A balloon mortgage is a mortgage where monthly payments are calculated on the basis of a 30-year amortization table but the balance of the loan is actually due less than the 30-year period. Most balloon mortgages mature between five to ten years from the date of the occurrence of the loan. If a borrower has a balloon mortgage with a term of five years, at the end of the fifth year, the borrower will owe the entire balance, which is due to the lender to repay.
Balloon mortgage example
Here is a simple balloon mortgage example that will help you better understand how it works. If a borrower has a $ 100,000 loan with an interest rate of five percent and a five-year period, the monthly payment would be $ 536.82 USD. At the end of the five-year term, the balance of the loan, and the amount that would be payable to the lender, would be $ 92,366 USD.
A borrower in this situation may choose to simply return the full $ 92,366 USD to the lender at the end of the term. For most people, this is not a viable and realistic option. The borrower may also choose to refinance the existing loan, creating a new mortgage.
How to calculate balloon payment
In actuality, a balloon mortgage is described that way because the curve of the repayment schedule follows the shape of a balloon. It begins with a low introductory rate and then in just a few years the full amount is due to be paid off. Just like a balloon, the beginning is very small and in a short time it rounds out to the fullness of the circle. You will see balloon loans that are set to be repaid in 3, 5, or 10 years as the most common repayment terms. Until the term ends, the monthly payment is quite low, but at the end of the term, the full balance of the loan is due and payable.
Balloon mortgage pros and cons
You may wonder why anyone would use this type of a loan for a home mortgage or mortgage refinance. Some people plan to own a property for only a very short period of time before they resell it. Using a balloon mortgage means that they have a very low payment for the period of time that they own the home, and then they sell the home, which pays off the balance due. Because the lender knows they will be receiving the full amount of the loan in such a short time, they are willing to offer the extremely low rates for the beginning of the loan term.
Investors who don’t want to amortize the full value of the mortgage over a 30 year period and pay all of that extra interest really like this type of loan. However, for the average person who plans to live in their home for a number of years, this type of mortgage can be devastating. Unfortunately, many people took out balloon loans when the market was good and are struggling now to come up with a full payment or sell the home. This often puts a person in a situation where they might only be able to qualify for a bad credit mortgage.
If you have a balloon loan that is coming due, you will want to look at the different mortgage refinancing options that are available today. By converting the balloon mortgage to a conventional 30 year mortgage, you won’t be forced to come up with the entire amount right now, and can even out your payments for a period of time so that you can manage your finances. A balloon mortgage has its uses, but one must be careful to understand how it works.