A balloon loan is a mortgage that requires a large one-time payment at the end of the loan. In exchange, your payments will likely be lower for many years, until the balloon payment is due. Aside from this repayment obligation, a balloon payment is the same as a standard fixed-rate mortgage.
In general, the balloon payment is over two times the loan's average monthly payment, but it is often tens of thousands of dollars. Most balloon loans require a single large payment that pays the remaining balance.
Benefits of a Balloon Loan
- Balloon loans often forego the requirement that you make a down payment. Many home buyers are eligible for a balloon payment when they are not eligible for most types of loans. If you do not have the cash for a down payment now, but expect to receive a large lump sum in the next 5 to 7 years, a balloon loan may be ideal for your situation.
- More disposable income every month with lower monthly payments.
- Lower interest rate in many cases. Most lenders consider a balloon loan low-risk, as it matures within 5 to 7 years, rather than 15 or 30.
- Remaining balance may be refinanced. If you are unable to pay the remaining balance at the end of the term, you can apply for a resetting or refinance of the balance.
Downsides of a Balloon Mortgage
- Large payment due when the loan matures, usually within 5 to 7 years. This is the biggest disadvantage to a balloon mortgage. If you choose a balloon loan, make sure you have access to the money to pay off the loan at the end of the term.
- Higher risk of foreclosure. While every mortgage comes with the risk of foreclosure, this risk is higher with a balloon loan. Along with the large lump sum due when the loan matures, you may fail to qualify for refinancing.
- You may not be able to refinance before the balloon payment is due.
Balloon Loans and New Mortgage Rules
Effective January 2014, lenders must now comply with new mortgage rules, which were designed to eliminate surprises and debt traps for consumers. Among them is the Qualified Mortgage rule.
A qualified mortgage is designed to make sure you do not take out a loan you cannot afford. When a lender makes a loan that meets qualified mortgage standards, they gain legal protection if you later default, because the loan itself is deemed safe. This means a qualified mortgage cannot have risky features.
Risky features, according to the new mortgage rules, are terms longer than 30 years, interest-only payments or minimum payments that will not keep up with interest.
Balloon payments are generally considered risky, so many balloon loans will not meet qualified mortgage standards. This does not mean a lender will not provide the loan, but you may have greater difficulty qualifying.
There is an exception to this rule. Certain balloon loans may be considered a qualified mortgage if they are originated and held in a portfolio by a small bank or lender in a rural area.
If you are considering a balloon loan, you must think about whether or not you will be able to make the balloon payment when it is due.