When you are looking for options to refinance your mortgage or buy a new home, you may encounter different types of mortgage programs.
In this post, we will know more about one such mortgage program called Balloon loan mortgage.
A balloon mortgage loan is a mortgage often based on a 30 years amortization schedule with the unpaid balance payment at the end of a specific period of time which could be anywhere between 5-7 years.
The balloon loan mortgage may contain an option to reset the interest rate to the current market and extend the due date if certain conditions are met. Basically, you have low, or no payment for a certain amount of time.
This could be ideal for someone who is either living in the home for a short period or someone who is banking on increasing their income over the next few years. However, if the market is declining this mortgage could be very dangerous.
For example, if you got a mortgage for $200,000 with a 5-year term, this means for the first 5 years your mortgage payments would be amortized according to 30 years mortgage and by the end of 5th year whatever the balance amount is reaming you are expected to pay that in a lump sum.
Some balloon mortgage loans have a reset option which takes effect at the end of the loan.
When the borrower requests for a reset, which meant he wants the lender to automatically recalculate the mortgage at the current interest rate.
However, when no such option has been provided, it could mean that the borrower would either sell the property or refinance the home mortgage before the end of the term.
For borrowers who are looking for low and fixed interest rates on their loans, this could be a fitting financing scheme.
This is also comparatively shorter than most types of mortgage loans because they normally last for 5-7 years.
For individuals who are sure that they would not be staying in the property for more than seven years, a balloon loan could be one of the best choices for the mortgage.
A serious word of caution, expect a huge remaining mortgage balance at the end of the term that the borrower has to pay in full.
If you are a home buyer who expects a windfall or looking for a higher income in the next few years, a balloon loan could be for you.
From all angles, balloon loans are undoubtedly a whole lot riskier than conventional loans.
If your primary aim is to bring down your housing cost as low as you possibly can, and you are confident that you get out before the balloon payment becomes due, then you can go for it.
However, if your financial situation is a bit shaky and you are the type of person who would worry about not being able to refinance or sell in time, think twice and hard, you might be better off going for a conventional loan.
Let us learn all about balloon mortgages, why to get them, the advantages and disadvantages of a balloon mortgage, and the things one should pay attention to before you make a decision.
A balloon mortgage is a short-term mortgage usually for 5 to 7 years, but sometimes for as short as 2 years also.
A loan that has an initial period of low may be interest-only which is relatively low or no monthly payments and at the end of which the borrower is required to pay off the full balance in a lump, some manner is how a balloon mortgage is defined.
A balloon mortgage is distinct from other loans because it does not fully amortize over the life of the loan.
Those people who expect to stay in their current home only for a short period of time opt for a balloon mortgage.
As it comes with low monthly payments and a much lower overall cost, compared to the 20 or 30 years conventional mortgage period a balloon mortgage is paid off in a few years.
A borrower may intend to stay in his home and refinance before the balloon payment is due. He may be expecting a higher income by then, and feel confident to be able to handle a larger monthly payment.
So for example – Suppose a buyer gets a seven-year balloon mortgage to buy a home, the lender will then require him to make equal monthly payments for seven years at a fixed interest rate and the rate will definitely be lower than a traditional mortgage loan at the end of the seven years the borrower has to pay the remainder of the balance of the loan back to the lender.
The borrower can then pay in full or refinance the loan with the lender or a different lender or simply sell the house.
The interesting appeal of a balloon loan is that borrowers pay an intern for a few years and make no payment for the principle it is no wonder why many finance people also call them interest-only loans.
In a traditional loan, your monthly payments apply for the interest for the month and partial principal of the loan.
Normally you take a balloon loan structure for mortgages but is not unusual for borrowers to use this scheme for other types of large loans such as auto loans.
To get the monthly payments on balloon loans, lenders usually divide the loan over a standard 30 years period but some lenders use other computation methods such as interest only.
The borrower can request the lender for a reset so that it automatically recalculate the mortgage at the current interest rate, however, when no such option has been provided it can mean that the buyer will either sell or refinance the home before the end of the term.
This loan widens the eligibility stop of the loan because more people can now qualify to avail of financing.
So for borrowers who may be low in cash at the moment but are expecting a huge amount to come within the next 5-7 years this alternative home financing scheme is very appropriate.
The unique feature of a balloon mortgage is that it does not fully amortize over the life of the loan ideally the borrower will make a payment over a predetermined period of time usually five or seven years then at the end of the period, he pays for the full remaining balance of the loan at once.
You can understand that the remaining balance would be huge hence the term balloon payment.
However, looking at the current situation of the COVID-19 pandemic where many are out of employment it is a risky mortgage for homeowners and lenders.