How Does a Balloon Payment Mortgage Work?
The typical mortgage is set up so you make a specific payment every month, and at the end of the repayment term, you completely own your home. A balloon payment mortgage, though, is designed with a short repayment term and a large payment due at the very end of that term. The large payment is called a balloon payment, and it's important to understand the details if you're considering getting a balloon mortgage.
Balloon payment mortgages are typically amortized over 30 years, which means the payments are calculated as if you will be making them for 30 years. However, after the repayment period, typically 5 years or 7 years, the remainder of the balance is due. If you still have the mortgage when the balloon payment is approaching, you need to either gather enough cash to make the payment, sell your house to make the payment, or refinance your mortgage.
The specific details of the balloon mortgage will depend on your lender. Some offer the ability to convert the balloon mortgage to a traditional fully amortized mortgage without a balloon payment if you still have the mortgage when the balloon payment is due. Other mortgages, though, do not offer any guarantee that you will be able to refinance when the payment is due. If you can't come up with the payment, your home could go into foreclosure. That is why it is critical to understand the specifics of your mortgage and to know whether it is the best arrangement for you.
Planning to sell in a few years:
If you know you will sell your home to move out of the area or buy another home before the balloon payment is due, this type of mortgage allows you to get a lower monthly payment than a traditional 30-year adjustable rate mortgage or fixed rate mortgage.
Home is investment property:
Investors often use balloon payment mortgages because they earn enough income from renting out or selling the home to make the balloon payment when it is due.
Confident you will refinance:
You can pay off the balloon mortgage by refinancing, so perhaps you are confident interest rates are trending down or you know you will qualify for a lower interest rate in a few years after you put some effort into improving your credit score.