What is a Balloon Mortgage?
There are a number of ways to finance a home. The FHA loan, for example, offers flexible credit requirements and low down payment options — an ideal first-time buyer program. On the other hand, borrowers who can afford a higher monthly payment may opt for a 15-year mortgage to save on interest.
But what about a balloon mortgage? Though this type of loan makes sense for some borrowers, it might not be the best choice for you. Continue reading as we discuss the ins and outs of a balloon mortgage.
How does it work?
A balloon mortgage is a loan that’s paid off with a lump sum at the end of the term. In most cases, borrowers are only responsible for the interest until tackling the entire balance with the final payment. Lenders typically set up balloon loans to have shorter terms compared to the conventional 15- or 30-year mortgages.
Say you’re in the first few years of a 30-year home loan. If you look closely at your mortgage statement, you’ll see that your servicer applies the majority of your funds toward interest. Over time, though, you’ll start paying more on the principal as opposed to interest.
This payoff structure is known as amortization. Many borrowers tend to favor conventional mortgages because they don’t have to worry about an increase in their monthly payment. As long as they stay current with their loan, it will mature at the end of the term.
Homeowners with a balloon mortgage must have a different mindset. While they certainly must stay on top of their interest-only payments, they should also have an idea of when their final, larger payment is due. This begs the question of who makes a good candidate for a balloon loan.
Why would you get a balloon payment mortgage?
Let’s start with the obvious reason why you would opt for a balloon mortgage. Perhaps you’re in the market for a home but don’t intend to stay in the property for 10-plus years. Or maybe you want to spend the next few years saving as much money as possible for your forever home.
So who would most benefit from a balloon mortgage? Well, this type of loan may cross your mind if you see yourself earning significantly more income in the future. Balloon mortgages are also viable options for borrowers expecting to receive a windfall of cash, whether it’s from the sale of another property or an inheritance.
Balloon mortgage pros and cons
Here are the main advantages and disadvantages of a balloon payment mortgage.
Lower interest rate - Balloon mortgages often come with an incredibly low interest rate. That means borrowers who choose this particular loan end up keeping more of their money, at least prior to making their lump sum payment. You can then use those extra funds to replenish an emergency savings account, eliminate debt, or build a down payment fund for your next home.
Affordable payments - This ties back to the previous point. For some homeowners, a 30-year mortgage leads to a depleted budget and limited cash reserves. Alternatively, a balloon mortgage allows you to put your hard-earned money toward other expenses.
Straightforward qualification process - You can feel at ease knowing that you won’t have to jump through hoops in order to obtain a balloon mortgage. Just remember to have all necessary documentation, such as bank statements and W-2’s, organized ahead of time.
Higher foreclosure risk - There’s always a risk of foreclosure when financing a property. But that possibility increases exponentially with a balloon loan in the picture. It shouldn’t be much of a surprise when you consider the lump sum payment could be hundreds of thousands of dollars.
Huge payment at the end - Even the most disciplined borrowers struggle to put away funds for their balloon payment. Sure, it’s nice to have extra money every month for several years. But the unfortunate reality is that a lot of homeowners fail to save enough to pay off the balance when the loan comes due.
How to get out of a balloon mortgage
There are potential solutions if you’re facing an uphill battle with your balloon mortgage. We suggest talking to your servicer first and asking about a loan modification. Other, not-so-popular options include a short sale or bankruptcy.
Now, depending on current interest rates, a refinance could be the easiest way out of a balloon mortgage. You can boost your approval chances by improving your credit score and lowering your debt-to-income ratio (DTI).
Who knows? You might be looking at up to $1,000 in monthly savings with a mortgage refinance.
So call (800) 910-4055 and let one of our mortgage consultants find the right loan for you.