Balloon Mortgage: Definition, Examples, Pros & Cons
Published: October 13, 2023
Learn about balloon mortgages in finance, including their definition, examples, and pros and cons. Understand the ins and outs before making any financial decisions.
(Many of the links in this article redirect to a specific reviewed product. Your purchase of these products through affiliate links helps to generate commission for LiveWell, at no extra cost. Learn more)
What is a Balloon Mortgage?
When it comes to financing your dream home or investment property, you have several options to choose from. One of these options is a Balloon Mortgage. But what exactly is a Balloon Mortgage?
A Balloon Mortgage is a type of mortgage loan that offers lower monthly payments in the early years of the loan term, followed by a final “balloon” payment at the end. This final payment is typically much larger than the previous payments and is intended to pay off the remaining balance of the loan.
A Balloon Mortgage offers lower monthly payments initially, followed by a large final payment at the end of the loan term.
The final payment, known as the balloon payment, is typically larger than the preceding payments and is designed to pay off the remaining loan balance.
How does a Balloon Mortgage work?
Let’s take a closer look at how a Balloon Mortgage works. Suppose you take out a 5-year Balloon Mortgage with a fixed interest rate. In this scenario, you would make monthly payments based on a 30-year amortization schedule, which means the payments are calculated as if the loan was going to be paid off over 30 years.
However, at the end of the 5-year term, you would need to make a large balloon payment to fully pay off the remaining balance on the loan. This balloon payment can be quite substantial, potentially reaching tens or even hundreds of thousands of dollars depending on the size of the loan.
The Pros and Cons of a Balloon Mortgage
Lower Monthly Payments: One of the biggest advantages of a Balloon Mortgage is that it allows you to enjoy lower monthly payments in the early years of the loan. This can provide financial flexibility and may be particularly beneficial if you plan to sell the property before the balloon payment becomes due.
Shorter Loan Terms: Balloon Mortgages usually have shorter loan terms, typically ranging from 5 to 7 years. This can be attractive for individuals who prefer to pay off their mortgage quickly or those who anticipate a change in their financial situation in the near future.
Risk of Balloon Payment: The largest drawback of a Balloon Mortgage is the risk of the final balloon payment. If you’re not able to make this payment, you could face foreclosure or have to refinance the loan, which may come with additional costs.
Uncertainty: Balloon Mortgages can be unpredictable, as you may not know the exact circumstances you’ll be in when the balloon payment is due. It requires careful planning and financial management to ensure you’re prepared to make the final payment.
A Balloon Mortgage can be an attractive option for those seeking lower monthly payments in the early years of their loan term. However, it’s essential to weigh the advantages and disadvantages before deciding if this type of mortgage is right for you. If you’re considering a Balloon Mortgage, ensure that you have a solid plan in place to cover the balloon payment when it becomes due.
Remember, every individual’s financial situation is unique, and it’s crucial to consult with a mortgage professional who can provide personalized advice based on your specific circumstances.