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What is a balloon payment?

Learn more about mortgages with balloon payments

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What is a balloon payment?

A balloon payment is a larger than usual payment that comes at the end of your mortgage. This is different than the payments many homeowners have on their mortgages.

Fixed rate mortgages have steady interest and principal payments over the life of the loan. Your interest and principal costs will be the same on your first and last mortgage payment. Your mortgage bill only changes if the costs of your homeowners insurance, property taxes, and any mortgage insurance you may have changes.

If you have an adjustable rate mortgage, your interest costs might change over the life of the loan. These interest costs might go up or down, depending on how your rate adjusts. Your homeowners insurance, property tax, and mortgage insurance costs might change too over time, like they can change with a fixed-rate mortgage.

However, it is unusual to have sudden and dramatic increases in your requirement payments with fixed rate and adjustable rate mortgages. These increases can happen. For example, your monthly payment can increase significantly if your property taxes triple. If your adjustable rate mortgage allows for very large increases in your mortgage rate, your payments may go up a lot too.

Mortgages with balloon payments have large increases built into the structure of the loan. These aren’t payment increases that might happen. These are payment increases that will happen. As a result, financial professionals often consider mortgages with balloon payments to be risky loan choices for many homebuyers. Sophisticated real estate investors may use balloon payments as part of their investment strategies.

What is a balloon payment on a mortgage?

A mortgage with a balloon payment typically starts with lower monthly payments at the beginning of your loan term. At the end of the term, you’d pay a balloon payment that covers the remainder of your balance which offsets the lower payments you were making earlier in your term.

A balloon payment mortgage usually has a much shorter loan term than other types of mortgages. Other mortgages often require payments over the course of 15 or 30 years. Balloon payment mortgages are often for just 5 or 10 years.

How does a balloon payment mortgage work?

Your lender will calculate your monthly payments and give you a payment schedule that includes paying the remainder of the loan at the end of the term. The balloon payment is typically paid in cash or by refinancing the loan.

Refinancing a balloon payment mortgage is like refinancing other types of loans. You’ll need to meet your lender’s credit, income, and financial standards to get your refinance approved and you’ll likely need to pay closing costs.

One reason financial professionals consider mortgages with balloon payments risky is if you cannot get approved for refinancing, you may end up defaulting on your loan when the balloon payment comes due.

Balloon payment mortgage example

Take a look at this example of a 10-year balloon mortgage with a fixed rate for $250,000. For the purposes of this example, we’ve assumed that your monthly principal payment stays the same over the life of the loan:

Balloon Mortgage Amount $250,000
Monthly Principal Payment $1,000
Principal Balance Paid after 10 years $120,000 ($1,000 x 120 months)
Principal Balance Remaining $130,000

In this example, the borrower pays $1,000 per month toward the principal. After 10 years, there is still $130,000 in principal left on the mortgage. If this loan requires a balloon payment of the remaining principal balance, then the homeowner might be responsible for paying the entire $130,000 balance in one payment.

Carefully consider all the terms, conditions, and requirements of a mortgage that includes a balloon payment before choosing this type of home loan. Freedom Mortgage does not offer home loans that have balloon payments.

*Freedom Mortgage Corporation is not a financial advisor. The ideas outlined above are for informational purposes only, are not intended as investment or financial advice, and should not be construed as such. Consult a financial advisor before making important personal financial decisions, and consult a tax advisor regarding tax implications and the deductibility of mortgage interest.

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