A balloon mortgage is a special kind of home loan that can seem appealing at first. It offers lower monthly payments for a short time, which can be helpful for people who need some extra breathing room in their budget.
However, there’s a catch: at the end of the loan term, you’ll need to make a large payment to pay off the remaining balance.
This payment can be substantial, so it’s important you understand how balloon mortgages work and the potential risks involved.
If you’re considering a balloon mortgage, it’s essential to weigh the pros and cons carefully. On the one hand, the lower monthly payments can be beneficial for people who expect their income to increase in the future or who plan to sell their home before the loan term ends.
On the other hand, the large payment at the end of the loan term can be a significant financial burden if you’re not prepared.
Hence, in this article, we’ll take a closer look at balloon mortgages and help you determine if they’re right for your financial situation.
What Is a Balloon Mortgage?
A balloon mortgage is a home loan where you make smaller payments at the beginning, usually covering just the interest.
Then, after a set period; often five or seven years, you must pay off the remaining loan balance all at once in a large “balloon” payment. This payment can be thousands of dollars, so you need a plan in place to handle it.
Balloon mortgages may come with either fixed or variable interest rates. Some loans don’t reduce the loan balance during the term (this is called no amortization), which means you owe the full amount at the end.
Others allow interest-only payments, keeping monthly costs low at first.
How Does a Balloon Mortgage Work?
With this type of loan, borrowers enjoy low monthly payments for a short time. However, when the term ends, they face a big final payment.
In some cases, the mortgage may reset at the end of the term, turning into a more traditional loan with regular payments based on current interest rates.
This structure works well for people who expect to sell the home or refinance before the balloon payment is due.
Types of Balloon Mortgages
There are three main types of balloon mortgages, and each works differently:
No-Payment Balloon Mortgage
In this version, you don’t make any payments for a set time—usually five to seven years. But interest keeps adding up during that time.
Once the term ends, you must pay the full amount, including all the unpaid interest.
Interest-Only Balloon Mortgage
Here, you only pay the interest on the loan during the early years. You don’t reduce the loan balance until the final payment is due.
This can make monthly payments easier but delays building equity in your home.
Balloon Payment Mortgage
With this option, you make payments as if you have a 15- or 30-year mortgage. However, the entire remaining balance is due after just five or seven years.
It’s a way to have lower payments at first, but still face a large final bill.
Pros of a Balloon Mortgage
Balloon mortgages can offer lower interest rates compared to traditional fixed or adjustable-rate loans.
That makes them a good option if you don’t plan to stay in the home for long. For example, if you plan to move or sell within a few years, you might save money on interest.
This type of loan also works for people who get large yearly bonuses or expect their income to increase. They can make smaller payments now and pay the balloon amount later using those bigger payouts.
Cons of a Balloon Mortgage
While balloon mortgages offer short-term savings, they come with big risks. If you can’t sell, refinance, or pay the balloon amount when it’s due, you may face foreclosure.
Also, refinancing isn’t always easy. If your home loses value or you owe more than it’s worth, lenders may not approve your refinance.
Most lenders want you to have at least 20% equity in the home before they’ll agree.
Should You Get a Balloon Mortgage?
Balloon mortgages aren’t for everyone. They’re risky because your future plans might not work out.
If the market changes, you might not be able to refinance or sell when you need to. That could leave you with a huge bill and no easy way to pay it.
Only consider a balloon mortgage if you’re confident you’ll move or refinance before the loan term ends; and you have a backup plan in case things change.
How to Qualify for a Balloon Mortgage
To qualify, most lenders require:
- A credit score of at least 620
- Stable income and employment history
- A down payment (though this varies by lender)
Look for lenders that offer non-qualified mortgages (non-QM loans), these are more flexible and often include balloon options. It also helps to work with a mortgage broker who can connect you to the right lenders.
Ask the lender whether they will keep your loan or sell it, and whether they offer automatic underwriting to check your eligibility for other loans later on.
How to Pay Off a Balloon Mortgage
When the balloon payment is due, you have a few options:
Pay It Off
If you’ve saved enough or your income has increased, you can pay the full balance at once. This works best if you planned for it from the beginning.
Refinance
You can apply for a new mortgage; often a traditional fixed-rate loan, to pay off the balloon balance. This option works if you have good credit, reliable income, and enough equity in your home.
Sell Your Home
Many borrowers plan to sell before the balloon payment is due. If you sell the home in time, you can use the money from the sale to pay off the loan.
Final Thoughts
A balloon mortgage can help you save money in the short term, but it’s not without risk. Make sure you understand how it works, and have a solid plan in place for the future.
Whether you decide to pay it off, refinance, or sell your home, being prepared is the key to avoiding financial stress down the road.
