The Balloon Mortgage – Its Up’s, its Down’s, and its Loan Payments
What is Balloon Mortgage?
The Balloon Mortgage is a commercial loan/residential loan which does not amortize over the entire loan period. The borrower needs to pay an instalment for the loan period, thereafter, he has to repay the remaining outstanding balance in one go. Since this last tranche of payment is very large (multiple times of instalment amount), this loan is known as Balloon Mortgage.
How does it work?
Balloon Mortgages generally have short terms ranging from 5 to 7 years. However, the monthly instalments are designed as a typical 30 year loan and does not cover the entire loan payment. Post the loan period of 5/7 years, the borrower can have following options with him :
- Pay the remainder amount (balloon payment) in one go from your savings and close the loan in entirety
- Sell off the asset/property for which the loan was raised to cover the balloon payment
- Use the “Reset” option whereby the balloon payment gets converted into fully amortized loan at prevailing rates. However, this option may to be always available for the lender subject to terms and conditions.
Pros & Cons of Balloon Mortgage
Balloon Mortgages have a lower interest rates compared to typical 30 year Automatic Rate Mortgages (ARM) and have lower closure costs. They are also easier to qualify for and also provide flexibility of converting into fully amortized loan. However, these loans carry some risks are well. The borrower needs to have large sums at disposal to repay the balloon payment which could lead to liquidity crunch. Even if the borrower opts for conversion, interest rate risks persist for borrower, as prevailing rates are applicable.
Traditionally Balloon Mortgages were popular commercial loans but now they are even used as residential mortgage. It is advisable to check whether balloon mortgage fits your situation and financial goals before signing the contract.