A balloon mortgage feels a bit like a traditional 30-year fixed-rate mortgage loan. Only in a balloon mortgage, you’d have to make a big payment at the end of a set period of time.
It usually works like this: Your monthly mortgage payment is the amount you’d pay if you were paying off your balloon mortgage over a 30-year period, just like with a 30-year fixed-rate mortgage loan. But instead of taking the full 30 years to pay off your balloon loan, you must after a certain number of years — say five or seven — pay off the loan’s outstanding balance in full.
Say after making your monthly payments for seven years, you have a balance of $100,000 on your mortgage loan. You’ll then have to send a check for that $100,000 to your mortgage lender.
Of course, most people plan to refinance their balloon loans before they hit the payoff period. There aren’t many homeowners who can simply cut a check for hundreds of thousands — or even tens of thousands — of dollars when the balloon payment hits.
This leads to the risk inherent in a balloon loan. What if your home loses value after you purchase it? You might not be able to refinance your loan into a mortgage traditional one. That’s because most lenders require you to have at least 20 percent equity in your home before they’ll approve your request for a refinance. The odds are that you won’t have this equity if your home’s value falls.
What if you can’t refinance or make your balloon payment? Your lender might foreclose on your home.
Of course, there is an advantage to a balloon mortgage: It usually comes with a lower interest rate. This means that your monthly mortgage payments will be lower.
The bottom line? A balloon mortgage can save you money. But it also exposes you to plenty of risk.