Definition of a Balloon Mortgage
A balloon mortgage is a home loan structured with low payments for most of the term and a single lump-sum payment due at the end. The Consumer Financial Protection Bureau defines a balloon payment as any payment more than twice the average monthly payment on the loan—which could be tens of thousands of dollars.
In an interest-only balloon mortgage, your payments are applied solely toward interest until it’s time to make the final balloon payment. With other types of balloon mortgages, the payments may be applied to both interest and principal.
Balloon mortgages typically come with lower interest rates than conventional mortgages. The repayment term is also much shorter, often just five years.
How a Balloon Mortgage Works
Lenders often use the same amortization table for shorter-term balloon mortgages as they would use for a longer-term mortgage. In addition, many balloon mortgages are set up as interest-only loans, which means your monthly payments are only applied to the interest. This arrangement typically leads to a lower monthly payment than you’d have with a traditional mortgage. You’ll defer paying on the principal until it’s time to make the lump-sum payment, or balloon payment, at the end of your mortgage term.
Some homeowners choose a balloon mortgage because it can be a more affordable way to purchase a home. The lower mortgage payments can leave more room in your budget for other expenses.
While the payments might be low, the balance will be due at the end of your mortgage term. Make sure you have a plan to pay off this potentially large bill.
For example, say you want to buy a $250,000 home and you have a 20% down payment. You qualify for a balloon mortgage with a 5% interest rate and a seven-year term, amortized over 30 years. Your monthly payments will be $1,073.64. But at the end of the seven-year term, you’ll need to pay a balloon payment of $163,758.35.
Pros and Cons of a Balloon Mortgage
Low mortgage payments
Good for borrowers looking for a short-term mortgage
Could help you buy a home sooner
You’ll have very little equity built up in your home
Could be hard to refinance
Large bill at the end of your mortgage
Risk of foreclosure if you can’t make the final payment
- Low mortgage payments: By definition, a balloon mortgage has low payments for most of the term. This could make it easier to cover other expenses of homeownership.
- Good for borrowers looking for a short-term mortgage: If you’re planning to sell the home before the end of the mortgage term, a balloon mortgage may be a good option, since the proceeds from the sale could help you cover the balloon payment.
- Could help you buy a home sooner: Knowing you’ll have lower monthly payments may allow you to put more money toward your down payment or other expenses, which may help you purchase a home sooner.
- You’ll have very little equity built up in your home: Because your payments are going either entirely or mostly toward the interest during the term, you’ll make little or no progress on paying down the principal; therefore, you’ll have built very little home equity.
- Could be hard to refinance: Because you won’t build much equity, it could be harder to refinance or change your payment terms.
- Large bill at the end: One of the biggest downsides of a balloon mortgage is the enormous bill that comes due at the end of your term. Nothing is forcing you to save toward eventually making that payment—which may not be enough incentive for everyone. Even if you’re planning to sell the home just before the end of the term, a market downturn could mean that the proceeds of the sale may not be enough to cover the balloon payment.
- Risk of foreclosure if you can’t make the final payment: If you’re unable to make the balloon payment at the end of your loan term, your lender may foreclose on your home. A foreclosure or short sale will also negatively affect your credit score and ability to qualify for future mortgages.
- A balloon mortgage is a short-term home loan with low monthly payments and one large lump-sum payment due at the end of the term.
- Balloon mortgages tend to come with low interest rates and low monthly payments.
- Applying for a balloon mortgage could help you afford a home sooner, but there are risks involved.
- Because you’ll build up very little equity during a balloon mortgage term, you could have a hard time refinancing down the road.