Balloon Mortgage Explained

What is a balloon mortgage? It is a loan payment that expands after a certain term is expired. Sometimes, the lower interest term of the balloon mortgage can run out in as little as five years. You can also get a 10-year balloon mortgage. Basically, this instrument functions similarly to a standard long-term fixed rate mortgage with a delayed spike in payments at the end -- hence the term “balloon.”

To secure and finance a big balloon mortgage, ask your lender when the balance of the money will be due, and understand the interest rate implications. It might help to compare balloon mortgage financing side by side with standard fixed rate mortgage financing.

Many homeowners who sign up for balloon mortgages do so on expectations that they can refinance before the term comes due. These homeowners don't want to pay full price for their homes, and they expect a bump in income to help them countenance later term balloon payments.

To protect your pocketbook, map out worse case scenarios. If housing interest rates go up years from now, you may have to refinance at that higher rate, thus taking longer to pay down the principal.

If rates spike up five percent or more from when you first lock in to your mortgage, your lender may actually have to reappraise your qualifications. Moreover, if you lose a major source of financing in the interim, you could be stuck with huge payments down the line. Just because your lender contract guarantees the potential to refinance later doesn't mean that you can't lose that privilege. Find out how and why a lender might disqualify you for refinancing the balance before you sign on.

If you don't plan on staying at your property for more than a few years, a balloon loan might be a good short-term, low-cost way to afford a nice place. Remember that you're basically betting against future problems when you sign up with this kind of instrument.

It's a good idea to create a payment strategy to tackle those future payments or at the very least to refinance before those payments come due, so you're not left in the lurch when your low-cost term expires.