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Balloon Mortgages

May 29, 2008  |  Difficulty: Easy

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You may have heard about balloon mortgages. You may have heard good things, and then, you may have heard bad things about this option. So, which information is true? Let’s go past the legal jargon and talk balloon mortgages in plain terms. Then, you will be in a better position to form your very own opinions.

With balloon mortgages, you will need to pay the entire loan before the term is over. During this term, you will make monthly payments that will be based on your amortization schedule. When the mortgage term is over, you are required to pay the remaining balance in full. This ending payment is called the “balloon” because you are paying off the total amount of the loan.  

Does this seem unrealistic? Not to some. When a buyer is looking for fantastically low interest rate, and plan to be in a home for only a set amount of time, this option can work. But if that buyer decided that he or she wants to stay in this home for a longer period of time instead of selling, refinancing would need to take place when the mortgage is due.

Balloon mortgages are usually the same terms as traditional mortgages. The term is likely 5 or 7 years. In financial terms this type of loan will be described as 5/25 or 7/23. But, if you need a shorter or longer term, you can arrange this. Terms can be between 3-10 years.

Many may wonder if they should choose a balloon mortgage or an ARM (adjustable rate mortgage). An ARM will have an interest rate that changes every six months or every year. If the market rates are increasing, so will your ARM interest rate. But, with a balloon mortgage, you will typically have only one interest rate change after the initial rate has been established. Balloon mortgages have great initial interest rates that can be up to 1%-2% lower than average rates.

Are there drawbacks to balloon mortgages? Yes. With an ARM there is room to negotiate, with the same lender, another mortgage after the initial mortgage term is over. But if you take on a balloon mortgage and there is a need to refinance, the process can be more difficult and expensive. If the market rates are increasing, there is a good chance that you will have extra fees and other problems. In the case that the market rates make a 5% increase, you may need to re-qualify for a loan and have your home reappraised. This can be a pricey process and can affect your new mortgage loan, especially if your property value is appraised lower than you were expecting.

So, make the comparison. Look at the benefits that are offered with a balloon rate and stand this next to the advantages of an ARM. When you compare prices and the overall profit from each option, you will be able to see what choice is best for your needs. To find the best rates and options, ask these questions:
  • What is the interest rate?
  • When will the balance be due?
  • Do I have refinancing options? What are they?
  • Can my refinancing options be lost or forfeited? How?
  • After the balance is due, will I have to re-qualify for a mortgage?

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