A balloon mortgage is a short-term mortgage that typically results in much lower monthly payments. Borrowers, however, must make a large "balloon" payment at the end of a short mortgage term to pay a significant portion of the mortgage. For investors, these mortgage plans can be ideal, particularly if they yield large profits from a property in the first few years. However, balloon mortgages are highly risky, and you should consult with a financial planner before taking out such a mortgage.
Balloon Mortgage Basics
Balloon mortgages can be taken out for any standard mortgage term, but many people who receive balloon mortgages use 10-year mortgages. At the end of a set period of time -- usually five or seven years -- you must either pay off the mortgage or obtain a new loan. Balloon mortgage rates are typically lower than traditional mortgages.
If you can't pay off your balloon mortgage when the balloon payment is due, you will have to refinance your mortgage. This can result in an ongoing cycle of debt that makes your mortgage payments last much longer than a traditional mortgage if you repeatedly are unable to make balloon payments. If your income drops or your credit deteriorates before the balloon payment is due, you might have trouble getting refinancing.
When you take out a balloon mortgage, your repayment schedule is based on the life of the loan, but the loan becomes due within a few years. While this payment schedule reduces your monthly payments, it also means that most or all of your monthly mortgage payments are interest payments. This can significantly reduce the equity you have in your home and -- if the value of your home drops -- can quickly send you underwater on your mortgage.
Foreclosure is the most serious risk of a balloon mortgage, which account for a much higher percentage of foreclosures than they do of loans. In Delaware, for example, 17 percent of loan foreclosures are on balloon mortgages, according to a study by the Reinvestment Fund. If you are unable to make your balloon payments and can't get financing, you can quickly end up in foreclosure.
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