What It Is

It is a mortgage that is not completely paid up during the course of the documented term, leaving a sum pending at maturity. This sum originally was meant to be paid all at once as it is now in some cases. The name “balloon” comes from the small installments suddenly “inflating” into a large payment. In spite of this type of loan being more common in commercial real estate, it is also used in residential property, with a variation.

How It Works

There is a short period at the beginning, usually 7 years, with fixed payments that give the borrower a lower interest rate and the security that the payments will not change. To the lender, on the other hand, it will also give security against the risk of a rate stampede, giving way to the variation mentioned above.

A Two-Step Loan

The balloon portion of the loan can be financed into the rest of the 30 year term, with the necessary adjustments and allowing lenders and borrowers to renegotiate the loan terms.

This is often called a “two-step loan” and the amount that corresponds to the balloon must be stated at signup. In some contracts the “reset option” is mentioned as available and it will be implemented only if the borrower is still the owner of the property.

Confusion

Balloon mortgages are sometimes confused with adjustable rate mortgages, because of the periodic adjustment in the latter and the one-time adjustment of the former. Nevertheless, it is only the borrower who might confuse the names before taking the loan, thus preventing him or her from taking a different option, should it be convenient.

Sometimes It Is Very Convenient

You can take a balloon loan for the purchase of property or maybe a car, knowing that after a certain period of time you will have the cash or the means to pay the balloon lump sum. In this case it is convenient because you are saving money on interest and you have a small monthly payment.

Depending on the repayment system used, you will have interest only payments, as installments and the balloon portion will be the principal. Other systems have interest and principal spread out evenly.

Two Flavors

Balloon Mortgages come in two possible options, if we look at the payment layout: There is a 5/25 Convertible and a 7/23 Convertible “model”. This means that the initial portion of the loan is paid in instalments for the first 5 or 7 years and the remaining 25 or 23 are for the balloon portion, respectively.

One thing to remember: If the reset option is available in the contract, it will be implemented only if there are no late or skipped payments during the last 24 months, indirectly helping you to keep your credit rating high.