If you can't qualify for a traditional mortgage, or if you're looking for a lower interest rate, you may opt for a balloon mortgage instead. With a balloon mortgage, you must pay the entire balance of the mortgage after only a few years. Since borrowers can't often afford this payment, many lenders include balloon riders on the mortgage documents.
About Balloon Mortgages
Most mortgages spread payments evenly over a certain number of years. With a balloon mortgage, on the other hand, you will make low payment for a certain number of years, but the rest of the mortgage's balance will be due after these years have passed. For example, for a $150,000 balloon mortgage with a seven-year term and a 5-percent interest rate, you would pay only $805.23 per month. However, the remaining balance of $132,723.09 would be due after seven years.
If you can't afford to pay your final balloon mortgage balance, a balloon rider gives you the option to refinance or modify the mortgage instead and keep making monthly payments. If you use the balloon rider to refinance or modify the mortgage, you will have a new due date and interest rate. The interest rate on the new mortgage typically depends on current market rates, as well as any premiums the lender charges for the balloon rider. For example, the lender may calculate the new interest rate as the going rate for 30-year mortgages plus 0.5 percent.
Most balloon riders offer a conditional right to refinance or modify, which means that you can't use the rider unless you meet certain conditions. To use Fannie Mae's balloon rider option, for instance, you can't have any other liens on your property, and you can't make any late payments in the year before your final balance is due. You must also use the property as your main home, and you must tell the lender that you plan to use the refinance option at least 45 days before your final payment is due.
Balloon mortgages are easier to qualify for than traditional mortgages, but they are a risky choice if you can't make the payment when the mortgage term ends. Before agreeing to a balloon mortgage, read the balloon rider and other mortgage documents carefully and make sure you understand the rules for refinancing. If you reach the end of the term and can't use the balloon rider to refinance, you may be able to pay the balance by refinancing with another lender or selling the home.