Balloon Payment Mortgages: Definition and How They Work

How Does a Balloon Payment Mortgage Work?

Your lender will calculate your monthly payments and provide a payment schedule that includes paying the remaining loan balance at the end of the term. 

One reason financial professionals consider mortgages with balloon payments risky is that if you can’t get approved for refinancing, you may end up defaulting on your loan when the balloon payment comes due if you can’t afford the large 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 doesn’t offer home loans that have balloon payments.

How Balloon Mortgages Can Be Paid Off

There are several ways to make your balloon payment once the lump sum is due. The right option will depend on your situation, including market conditions, your financial picture, and the total amount owed. 

Options include:

• Refinancing: Just like when you refinance other types of loans, refinancing a balloon mortgage requires you to apply for a new home loan. Refinancing a balloon payment mortgage is similar to refinancing other types of loans. You’ll need to meet your lender’s credit, income, and financial standards, and you’ll probably have to pay closing costs. When refinancing, you'll use the proceeds to pay off the entire balance due, then work on paying your new lender.  
• Selling your home: Selling your property is another option, as you can repay the balance from the proceeds of the sale.

If you have enough savings, you could also repay the loan balance in full when it is due.

Why People Use Balloon Mortgages

There are several potential reasons why borrowers use balloon mortgages. Here are some of the most common reasons:

• Lower payments at first: Balloon mortgages often have much lower monthly payments from the start. Your payments are lower because you are not repaying the full balance due in equal monthly payments. You pay only a small amount, then repay the remaining balance with your lump sum payment.
• Short-term stays: If you only plan to use the property for a short period of time before selling, a balloon mortgage can provide an affordable monthly payment. The balloon payment can be made in full from the proceeds of the sale.
• Commercial real estate: If you are investing in commercial real estate, balloon mortgages allow you to buy properties while maximizing your cash flow by keeping monthly payments as low as possible.
• No prepayment penalty: If balloon mortgages do not have a prepayment penalty, you can pay them on a schedule of your choosing, including before the large lump sum payment comes due. 

Risks of Balloon Payment Mortgages

There are also significant risks of balloon payment mortgages. Some of the biggest risks include the following:

• Large balloon payment: You must prepare for a large balloon payment, which can be a major financial burden with a strict deadline. 
• Higher interest rates: Balloon payment mortgages sometimes come with higher interest rates than more traditional mortgages because of the added risk the required balloon payment represents. 
• Foreclosure: Owing a large lump sum payment creates a risk of foreclosure if you can't refinance, sell, or cover the bill from savings.

Balloon Payment FAQs

Still need to know more? Here are the answers to some frequently asked questions about balloon-payment mortgages.

Is a Balloon Mortgage a Good Idea? 

A balloon-payment mortgage is a risky type of home loan. While it may seem like a good option if you need a loan with affordable monthly payments, you take a significant risk of not being able to afford the balloon payment and losing your home to foreclosure. 

When Is a Balloon Payment Due? 

When you take out a balloon payment mortgage, you will need to make a large balloon payment on the maturity date of the loan. This is determined based on your specific loan agreement with your lender.

Who Should Consider a Balloon Mortgage Loan? 

You should consider a balloon mortgage loan if you need more affordable upfront payments and are willing to take on the risk of a balloon payment. Make sure you are confident that you can make the balloon payment when it is due.

What Are Good Alternatives to Balloon Mortgages? 

Adjustable or fixed-rate mortgages are good alternatives to balloon mortgages. These loans do not have a large lump sum payment at the end of the term, so they don't present the same risk. However, your regular monthly payments may be higher than with a balloon mortgage. 

Final Thoughts: Understanding the Long-Term Impact of Balloon Mortgages

Balloon mortgages present a substantial risk, and you should make sure to explore all other options before deciding to use this type of loan to purchase a property. Freedom Mortgage does not offer balloon mortgages, but our mortgage loan professionals can help you explore other loans within your budget that make sense for your financial needs. Reach out today to learn more.