A balloon mortgage is a lending product that offers financing for a home in the same way that a traditional 30-year-fixed loan does. It just comes with an unusual twist. You’ll still make a normal set of monthly payments for a set time, which is usually 60 months. Some lenders will extend you to 84 months. Then you must make one large payment that covers the remaining balance of the loan.
It is that large payment that becomes the “balloon” component of the loan. Depending on the size of your mortgage, you could be looking at a cost of more than $100,000 when the terms are due.
You’ll want to work with your lender on what the repayment plan would be so that you know what the final balloon payment would be. It is not unusual for the final payment to be 90% of what the lending amount was on the initial offer. If you’re unable to pay that amount or work out an alternative arrangement, then you will face the foreclosure process.
There are several pros and cons of balloon mortgages to consider before deciding that this option is the best one for your upcoming purchase.
List of the Pros of a Balloon Mortgage
1. A balloon mortgage offers an affordable initial cash outlay.
When you compare the down payment requirements of a balloon mortgage against the more traditional options that are available today, buyers can get away with a lower down payment. That means more people can qualify to purchase a home using this option since there isn’t a requirement to have 20% down to avoid having PMI placed on their loan. That’s why this choice can be beneficial, especially if you’re expecting to come into a large sum of money in the near future.
If you can find a lender that still offers a balloon mortgage for a home purchase, then it is usually easier to qualify for this loan because of the structure of the final payment.
2. Lower interest rates come with a balloon mortgage.
Another option to consider with a balloon mortgage is the fact that almost all of the risk of the loan sits with the buyer. That means the interest rate for the loan is typically much lower than what you’d get as an offer for a 30-year-fixed product. You’ll need to be aware of the shorter payment terms with this choice, which are typically in the 5- to 7-year range. That’s why most lenders consider this loan choice to be a low-risk option.
You might find that some offers come in at a full percentage point lower than what you’d receive with a 30-year-fixed mortgage. These loans typically have less interest than an adjustable-rate mortgage as well since the buyer is assuming most of the risk in the transaction.
3. You can refinance the remaining balance if necessary.
If you find that your finances will not allow you to pay the entire balloon payment that comes due at the end of the mortgage, then there is an option to refinance the loan. Some lenders might allow you to reapply for a “reset” where the terms start over again with another down payment or another option. You can also go through a traditional refinance where the mortgage converts to one of the more traditional lending options. You’ll face a higher interest rate at whatever the prevailing market rate is at the time, but it also means you can get into a house faster right away while still having options later.
4. You can be free of the debt from the property purchase in less than 10 years.
A standard loan, like a 30-year-fixed mortgage, is one that fully amortizes over its lifetime. That means you are paying down the balance slowly over the entire life of the lending product with payments that are either structured or reasonably predictable. That also means that you’re going to be stuck with that debt for a long time.
When you can afford a balloon mortgage, then you’ll primarily pay the interest on your loan until the time comes to pay the entire thing back. That means you’re wiping out the entire balance at once, so there isn’t a gradual shift toward principal repayment as there would be under a standard amortization scenario.
5. Business loans can take advantage of the balloon payment structure.
Although balloon payments are somewhat rare today for residential purchases, you can still find them available for business needs. If you’re starting, purchasing, or expanding an entrepreneurial opportunity, then this type of loan can give you relatively small payments for the first few years while you start building some profits. This option works well if you don’t have a credit history or there isn’t a lot of capital available to get things moving right away.
Once a business can establish a positive credit profile, then it is easier to refinance a loan if that final large payment isn’t payable. You can use this option for some construction or land loans when temporary financing is necessary to create results.
6. Your payment calculations are still reflective of a 30-year mortgage.
When you decide that a balloon payment is the right choice for your needs, then you’ll want to speak with your lender about what the terms will look like when that first check needs to get in the mail. Most financial institutions will structure your repayment plan to reflect what the payments would be if you received a 30-year mortgage, but you also receive the cash infusion right away to take care of your needs. That means you have time to purchase land, build a home, and then potentially refinance the higher value at the lower rate level from the balloon mortgage.
7. You can negotiate a “reset button” with some lenders.
Some balloon mortgages provide the option to have a reset at the end of the first term. You’ll go to a different interest rate based on what the market supports at that time. The lender will recalculate the amortization schedule based on the new terms as well. Then you can continue making the usual monthly payment until the balloon payment becomes due once again. This option works well for families who tend to move around a lot. You will need to speak with your mortgage provider to see if this option is available since some lenders do not offer it as an option.
If interest rates are currently high in the market, this advantage can help you to refinance the rest at a lower rate instead of a higher one. That means you’ll be paying mostly interest during the repayment terms, and then recalculating the amortization so that your balloon payment becomes more manageable in the future.
List of the Cons of a Balloon Mortgage
1. There is a significant payment due when the balloon mortgage matures.
The primary disadvantage of using a balloon mortgage for a home is that there is a lump-sum payment due when the lending product matures. You’ll need to have a plan in place right away that will help you to take care of this final payment. If you make $50,000 per year and opt for this loan because of the lenient down payment option, then there might not be enough time to raise the necessary funds to cover the payment at the end of the loan.
You may have refinancing options available to you under those circumstances, but it also doesn’t provide a guarantee that you can get out of the final payment. It will usually be tens of thousands of dollars that is due, which is why most lenders only recommend this mortgage if you’re expecting a large sum of cash in the near future.
2. You will run a higher risk of dealing with a foreclosure.
One of the primary drivers of the Great Recession was that there were a significant number of homeowners on a balloon mortgage who couldn’t afford their final payment. These households faced foreclosure because they were unable to sell their home on time, receive a refinancing offer, or come up with the money to pay off the loan. That’s why the interest rates are typically lower on this lending product. If you’re willing to face these risks, then you can get into a pretty good home at a decent rate. Part of taking a risk means that you might experience a loss afterward.
3. Most lenders do not want to refinance balloon mortgages.
If you are only making the minimum payments for your balloon mortgage up until the final payment comes due, then there is an excellent chance that you’ll have negative equity in your home. Most lenders will not want to touch your request unless you can prove that you’ve got 20% equity available – or the ability to cover that amount in a down payment. The government can sometimes help you with subsidized programs if you haven’t missed any payments, but there are no guarantees here with this disadvantage.
Whether you end up paying 90% to clear off your mortgage or you pay 20% (or more) to ensure that you’ve got some equity in the property, there is usually a large chunk of money that you’ll need to stay on your property.
4. The value of your property might go down.
Let’s say that you decide to purchase a home in a nice neighborhood for $200,000. It seems like a great deal at the time, and you’re fairly confident that there is a promotion coming at work that will help you to cover the cost of the final payment after seven years. Now let’s fast-forward to the time when the final payment is due.
That promotion might have happened, but it didn’t provide as much money as you thought it would. In the meantime, property values in your community went down by 20%, so now your home is only worth $160,000. In this situation, your options to sell or refinance might disappear immediately because at a 4.5% interest rate, you’d owe a payment of more than $175,000.
That’s why some families made the choice to walk away from their homes in 2007-2009 instead of looking for alternatives. You can get so far underwater with a balloon mortgage that there is no way to recover.
5. Most lenders will not offer a balloon payment today.
Balloon mortgages were a popular option in the 2000s before the housing market crashed because it seemed like easy money to many lenders. Most institutions learned their lesson from the fallout of those decisions, so it is somewhat unusual in the United States to find this lending product today. If you can prove that there is a significant amount of money headed in your direction over the terms of the loan, then some lenders might be willing to look at this type of mortgage to help you to purchase a home.
If you can’t prove your income, then an adjustable-rate mortgage is the better option if you need a lower down payment. Most ARMs today have rate caps that limit how much your payments can rise in any given year. You’ll also get to avoid the looming problem of the final large payment.
6. The amortization structure can work against some borrowers.
One of the benefits of a balloon mortgage is that the amortization structure can offer you reasonably low monthly payments since the approach is similar to that of a 30-year lending product. This structure can also be a disadvantage unless you’re willing to pay down some of the principal on your balance each month. The primary amount that you’re paying to your lender over the 84-month term is the interest on the loan because the understanding is that the final payment will cover the remaining amount.
If the option to refinance disappears and you’re unable to afford extra each month on top of the regular payment, then you could lose your home when using this lending product.
7. It can leave an adverse impact on your credit score.
If you are unable to meet the obligation of the balloon payment with this mortgage option, then the foreclosure process could leave a severe impact on your credit history for up to a decade. According to information supplied by FICO, if your current credit score is 680, then losing your house will drop it by 140 to 160 points. You’ll see an even steeper drop if your credit score is higher than that.
If you already have a poor credit score (under 600), then there isn’t much damage left to be done. You might want to consider bankruptcy, which can decrease your score by up to 240 points, if it is debt that holds you back from fulfilling your final payment obligations.
8. You might still be liable for the mortgage debt after a foreclosure.
There are several states in the U.S. that are called non-recourse states. This term means that they are anti-deficiency states where it may not be possible to pursue your mortgage as a debt. Some states like California, Utah, Nevada, and New York permit lenders to pursue a single lawsuit to collect on mortgage debt, giving the institution the option to go after what you owe them in civil court or to proceed with a foreclosure.
As a general rule of them, the richer a lender thinks you are, then the more likely you are to see collection attempts occur.
9. It is easy to think that you can borrow more money with a balloon mortgage.
One of the underlying risks of a balloon mortgage is that some people can be fooled into believing that their small payments allow them to borrow additional money. If you’re only paying $1,100 per month for a $200,000 mortgage, then it might seem like you can afford a car payment and other debt at the same time. This chain of decisions leads many people toward financial ruin because they should be using their extra funds to pay off some of the principal of their loan.
Even if you could only afford an extra $200 per month during the repayment terms, you could reduce the final payment obligation by more than $15,000.
10. Buyers must meet specific conditions to earn a balloon payment reset.
Although the remaining balloon mortgages that are available today contain an option to reset instead of requiring the final payment, buyers must meet some specific terms and conditions to qualify for this action. The mortgage holder needs to still own the home and occupy it as their primary residence; it cannot be an investment property. All of the payments from the previous year must have been made on time. Some lenders might even extend that requirement to 24-36 months.
There must not be any liens on the property when the reset occurs as well. That’s why it helps to know what the status of your deed is before approaching your lender for a reset. Even a false lien can prevent your reset from going through, which means you wouldn’t have time to clear the issue before the foreclosure process might start.
A balloon mortgage is not the right choice for most households because of the large payment that is due at the end of its terms. If you know that there will be a significant increase in your income in the next few years, then it could be an option. Families that know a settlement check or some other large income boost can use this knowledge to leverage a good rate for a home today to move in immediately. Then you can pay off the mortgage in 60 to 84 months so that you’re in a debt-free position.
Weighing the pros and cons of a balloon mortgage can also involve the amount of time you plan to be on the property. If you’re going to sell before the final payment is necessary, then you can manage your finances wisely.
If you are unable to make that final payment, then you will want to contact your lender as soon as possible. Some agencies are willing to extend the terms of your loan by a few years to help you cope with the balloon payment. There are instances when a refinance did occur, even with negative equity, because that option was preferable to the foreclosure process. If none of those options are available, then you might face a significant loss at the end of the loan.
Blog Post Author Credentials
Natalie Regoli, Esq. is the author of this post and the editor-in-chief of our blog. She received her B.A. in Economics from the University of Washington and her Masters in Law from The University of Texas School of Law. In addition to being a seasoned writer, Natalie has almost two decades of experience as a lawyer and banker. If you would like to contact Natalie, then go here to send her a message.