A balloon mortgage is a type of mortgage where the monthly payments are calculated based on a 30-year amortization schedule, but the balance of the mortgage is actually due in less than the 30-year term. Most balloon mortgages mature between five to ten years after the origination date of the loan. If a borrower had a balloon mortgage with a maturity date of five years, at the end of the fifth year the borrower would have to repay the entire balance that is due to the lender.
Here is an example of how a balloon mortgage works. If a borrower has a loan of $100,000 US Dollars (USD) with a five percent interest rate and a five year maturity date, the monthly payment would be $536.82 USD. At the end of the five year maturity period, the balance remaining on the loan, and the amount that would need to be paid to the lender, would be $92,366 USD.
A borrower in this situation can choose to simply repay the entire $92,366 USD to the lender at the end of the maturity period. For most people this is not a viable or realistic option. The borrower can also choose to refinance the existing loan, creating a new mortgage loan.
If the original loan agreement allowed it; the borrower could exercise a mortgage reset option. When a borrower resets the mortgage, the lender re-calculates the payment based on current mortgage rates for the remainder of the amortization period. Lastly, many borrowers simply opt to sell their homes on or before the maturity date. In fact many customers who choose a balloon mortgage do so with the assumption that they will be selling their home before the maturity date.
Balloon mortgages are often mistaken for and compared to an adjustable rate mortgage (ARM). In an ARM, there is a set period where the interest rate and monthly payment is fixed. After this initial period the interest rate and monthly payment can fluctuate based on market conditions and the terms of the loan agreement. In contrast to a balloon mortgage, at the end of the initial period of an ARM, the entire balance does not need to be paid off.
Many borrowers choose a balloon mortgage because they may offer favorable rates and lower monthly payments over a comparable ARM or conventional fixed rate mortgage. The lower rates and monthly payments may also help a borrower qualify for a larger loan than they would be able to with a conventional fixed rate mortgage or an ARM.
Factors that borrowers should be aware of with a balloon mortgage are:
• The loan will have to be repaid, reset or refinanced at the end of the maturity date.
• If the loan is refinanced, current market conditions could result in higher monthly payments.
• The lender may have certain qualifications that a borrower would have to meet before a borrower is able to reset a balloon mortgage. If these qualifications are not met, the borrower would then be forced to repay or refinance the mortgage.
