What Is a Balloon Payment for a Mortgage?

Thinking of how a balloon expands will help you understand how a balloon mortgage works.

Thinking of how a balloon expands will help you understand how a balloon mortgage works.

Now that the honeymoon is over, you and your new spouse are thinking about that next big step – buying a home. The only problem is sorting through all the information about different mortgage types that any quick Google search will return. Among the many mortgage programs you’ll read about is a mortgage with a balloon payment. Understanding what it is will help you determine if it is the best option for you.

In a Nutshell

Think of the physical aspects of a balloon to understand how it applies to a mortgage loan. With a balloon mortgage, you agree to make fixed payments for the term of the loan, with the exception of the final payment. The payments are smaller than with standard 30-year fixed-rate loans, but the loan doesn’t fully amortize over the course of the loan. What that means is that the loan doesn’t come to gradual fruition as with a traditional 30-year fixed-rate mortgage in which the final payment is equivalent to all the previous payments. So, while you are making smaller monthly payments, the final payment amount continues to grow or balloon, resulting in a larger final payment that satisfies the remaining balance of the loan.

Details

The term for a balloon mortgage can range between one and 25 years, although such mortgages commonly span anywhere from three to seven years. Under the Home Ownership and Protection Act of 1994 (HOEPA), balloon payments are prohibited on high-interest, high-fee home equity loans with terms of less than five years if the regular payments do not pay off the principal and if the balloon payment is more than twice the regular payments.

Advantages

The biggest advantage of a mortgage with a balloon payment is being able to make smaller payments for a period of time. This could be ideal for getting other financial obligations, such as car payments and school loans, satisfied quicker. Lower monthly payments are also beneficial if you don’t plan on staying in the house and are sure you can sell it for a profit before the balloon payment is due. You may also find a balloon mortgage suits you if you have a reasonable expectation of increasing your income dramatically -- perhaps one of you will be finishing college and beginning your career before the balloon payment is due.

Disadvantages

Unfortunately, unless you have a crystal ball you really don’t know what your financial future holds. While you may have set up a budget and planned for the balloon payment, the unexpected can always rear its ugly head. You may lose your job or some other unforeseen circumstances may strike at the heart of your savings account, leaving you unable to make the large balloon payment. Refinancing may be an option, depending on your financial situation, but interest rates may be higher. If you aren’t able to make the payment or refinance, you run the risk of losing your home.

About the Author

Based in South Florida, Leann Harms has been writing since 2008. Her design, technology, business and entertainment articles have appeared in "Design Trade" magazine and Web sites including eHow. Harms has a Bachelor of Arts in English from Florida Atlantic University.

Photo Credits