Every homebuyer’s situation is unique, and because of that, there are numerous mortgage options available to accommodate borrowers. A balloon mortgage isn’t as common as other types of home loans because there can be a higher level of risk involved compared to more conventional options. However, for some borrowers, the advantages of a balloon mortgage can outweigh the potential disadvantages.
Balloon mortgages start off with fixed monthly payments for a few years, but then borrowers will be required to pay the remaining balance all at once, which is known as the balloon payment. Prior to the balloon payment, however, monthly payments are typically lower than they would be compared to mortgage payments with a more traditional structure.
With a balloon mortgage, the term (number of years that the borrower has to repay the mortgage) is much shorter than the amortization period (the number of years over which the mortgage’s payments are calculated). For instance, with a conventional 30-year fixed-rate mortgage, borrowers will have the same monthly mortgage payments each month throughout the life of the loan, which is 360 payments in total.
Balloon mortgages are structured differently. Instead, a borrower may have a different fixed-term: for example, 10 years, with a 30-year amortization. Your monthly mortgage payments will be the same for those 10 years as though your mortgage term is 30 years, but after that 10-year period is up, you will be required to pay the remaining balance all upfront.
Benefits of balloon mortgages
The shorter term that comes with balloon mortgages can be a major advantage, depending on how you look at it. Ultimately, you will be required to pay off your home loan sooner with a balloon mortgage. But with a shorter loan term, this means it costs you less overall because you’re paying less in interest over the life of the loan. This can give you the unique opportunity to own your home free and clear in just a fraction of the time, whereas most homeowners take 30 years to pay off their mortgages.
Another appealing benefit of balloon mortgages that are often the primary motivator for borrowers is the lower interest rate. Qualifying borrowers are likely to have lower monthly payments through the initial fixed period due to more favorable rates.
When you combine the larger loan limits with lower interest and monthly payments, most borrowers find that balloon mortgages give them the opportunity to afford their dream home. The flexibility means that homebuyers can typically borrow more, which may be necessary, depending on the home they’re hoping to purchase. However, it’s also important to carefully consider whether borrowing more just because you can is worth doing, and that the purchase price of the home you are considering is still reasonable and feasible based on your budget. You have to consider the cost of upkeep and maintenance, property taxes, associated costs of living, and other factors. Most importantly of all, you have to be certain you will be adequately prepared for the balloon payment.
Drawbacks of balloon mortgages
Although balloon mortgages are a favorable solution for some borrowers, there are also potential drawbacks to consider.
One disadvantage is that borrowers may face difficulties refinancing if they eventually change their minds and prefer a different type of mortgage. To qualify for a refinance loan, a certain amount of home equity is typically required, and borrowers with balloon mortgages often don’t have much (or any) equity until the end of their loan term anyhow. Market changes can also make it harder to refinance if property values decrease. Alternatively, you may be able to refinance into a different mortgage if you have enough liquid cash at closing.
If you’re looking into balloon mortgages because you’re looking for an option that offers a more favorable rate, a balloon mortgage may not necessarily be your best choice. FHA, VA, and USDA loans, for example, may all offer lower interest rates and other appealing qualities, like lower down payment requirements. Additionally, because these mortgages amortize completely, borrowers don’t have to be concerned about the balloon payment. However, it’s important to note that eligibility for these other types of mortgages is based on specific criteria. And when it comes to balloon mortgages and mortgage rates, the possibility of market condition changes and interest rates going up or down can significantly affect the overall affordability of the mortgage.
One of the biggest drawbacks of balloon mortgages that buyers have to consider is that this type of loan is potentially high risk. If you are unable to refinance by the time the balloon payment is due, you will need to have a lot of money saved up in order to handle that payment. You may have had every intention of saving up the money needed to make that balloon payment, but sometimes, life can be unpredictable. Because this can put you at a higher risk of losing your home to foreclosure, it’s crucial to consider both the pros and cons very carefully before making your final decision.
Calculating monthly balloon mortgage payments
Calculating the mortgage payments over a fixed-rate term is pretty straightforward, as your payments won’t change over the course of your loan. At the very least, your interest and principal won’t change with a fixed-rate mortgage unless you refinance. Calculating monthly balloon mortgage payments can be a little more complex, but this is an essential step to understanding how these types of loans work and whether it’s a structure that works well for you and your financial situation.
Example #1: You’re borrowing $300,000 in a seven-year balloon mortgage, and you’re making interest-only payments of $1062.50 each month. The payments don’t change throughout those seven years, but because they are interest-only payments, the balance on the loan doesn’t go down, either. You would be required to pay $300,000 at the end of the seven-year term.
Example #2: You’re borrowing $150,000 with a longer 17-year term, and with a structure that includes both principal and interest each month. Monthly payments begin at approximately $966 and gradually increase over the years, eventually ending around $1,897 each month. At the end of the term, there’s a $17,500 balloon payment, which equates to remaining balance on the loan.
Making the actual balloon payment
Buyers seriously considering a balloon mortgage need to be prepared for making the inevitable balloon payment. It’s helpful to explore the various options for satisfying this debt ahead of time, which can help you make your final decision about whether a balloon mortgage is the right choice for you.
Some options for making your balloon payment include:
Paying it off with cash. This is the straightforward option for handling balloon payments, and often the intention that borrowers have in mind when they make the decision to take out a balloon payment. If you’re unable to pay off the balloon mortgage with cash you’ve saved up, however, you may be able to take care of the balloon payment with another option.
Selling your home. You may have the option to sell your home and use what you make to pay off the mortgage balance. However, this option will only work if the proceeds will cover the mortgage balance. Real estate can be unpredictable, and it can be hard to know what the market will be like when your balloon payment is eventually due. If there is a mortgage and housing crisis, your home may be worth significantly less than what you anticipated. On the other hand, you may make far more than you expected if you sell when the market in your area is hot. If you know you definitely want to sell your home when the balloon payment is due anyhow, and you’re confident in the home values in your area, a balloon mortgage can be worth considering. On the other hand, if you would only want to turn to this option as a last resort because you’re looking to purchase your forever home, a balloon mortgage may not be ideal. Additionally, you may want to explore alternative mortgage options if you’re too uncertain about how housing conditions will change over the years, or if you’re simply not comfortable with the risk.
Refinancing. Converting your balloon mortgage into a new loan will extend your repayment period by several more years, giving you more time to come up with the cash needed for your balloon payment. Alternatively, you may have the option to finance your balloon mortgage into a 30-year or 15-year fixed-rate mortgage. Qualifying for an entirely new loan will mean meeting the same requirements as though you’re applying for an initial fixed-rate mortgage; good credit, as well as steady and adequate income, are a must.
Apply for a loan or refinance your current mortgage with Filo Mortgage
If you’re purchasing a home and looking to explore your mortgage options, including balloon mortgages, we’re happy to help and give you more information, as well as assist with the application process. If you already have a balloon mortgage and you’re looking to refinance, we’re also available to explore the different options that are available to you for refinancing. Contact Filo Mortgage today!