What is Balloon Mortgage?
Today we’re talking about balloon, what exactly is balloon loan? You might be thinking about a vision of your mind about a balloon exploding or popping that’s what I always think about whenever I think about a balloon loan. It really plays a big role in investment properties, commercial mortgages not so much in residential although it can depending on the type of loan that you’re doing. Basically a balloon loan is a loan that dosen’t fully amortized over the time that mentioned in the term of the loan.
Whenever you’re taking a loan for a certain duration of time and then it leads to a maturity date when the full loan amount is due. I give an example, so let’s say that you close on your house or you close on an apartment complex and there’s a $200,000 loan and your payments are based on a 30-year schedule. So you pay $800 a month 30-year loan. but in the contract it’s written that the loan was for “two years term” it’s not going to say the word “balloon” on it but that’s what that means two-year term. That means that in two years that you have to pay off the remaining balance that you owe to the lender.
Your payments aren’t based on a two-year amortization your payment’s based on a 30-year amortization but the loan is due in two years, you either have to extend the loan after two years, refinance the loan or pay off the loan you have three different options at the end of the two year period. So that’s what a balloon means. Balloons are not bad it’s just you need to be aware of what you’re getting into, most commercial loans-guys have a balloon on them Fannie Mae, Freddie Mac they have balloons connected to them too. Where there’s a maturity date and they want that loan either refinance paid off or property sold or you file an extension to extend the loan out further but you have to do something with it in that extra time.
Let’s say you’ll Refinance, assuming you can’t pay the balance. So this gives the lender a little more security because there’s been an increase in interest rates now. When you refinance the lender can charge you that that higher interest rate. So if we started with an interest rate of 4.5% now it’s at 12%. So now the lender can say “Yeah, I will let you refinance, no problem. That’s written into the contract now you got to pay 12% interest.” So you might be thinking then okay well why would a borrower ever agree to this bloomers? Isn’t there a lot of risk here?
Why should I choose Balloon Mortgage over Adjustable-Rate Mortgage?
Well, there’s you’re exposed to changes in interest rates, now of course if interest rates go down it could actually benefit you but you’re getting a lower interest rate upfront. So you’re getting a benefit from this up front. You might be thinking well what about an adjustable rate mortgage how does an (ARM) loan different than what’s happening here? We have this this 4.5% interest rate that we start with well maybe with an ARM loan it might have a limit. An ARM loan might have a cap where it says at the end of five years the interest rate even if it’s at 12% you can only increase by 3% of what the original value was. So it can just go up to (4.5% + 3%). So we go to 7.5% you’d have this cap kind of protecting you with it with an adjustable rate mortgage loan. A balloon mortgage is in that sense could be more riskier than an adjustable rate mortgage because you don’t have that cap and so there’s no cap and you don’t have that cap protection, in exchange though you’re getting that lower interest rate upfront than you would with an adjustable rate mortgage loan.
So something to think about is that if you plan to sell your home before the balloon comes due? Maybe it’s worth saying “You know what, I really get the cheapest interest rate by doing the balloon mortgage and I’m gonna sell before the balloon comes due. So then I don’t have to worry about refinancing and possibly incurring a much higher interest rate.” Then a balloon mortgage might be a more attractive option than an adjustable rate mortgage loan or even a fixed-rate mortgage because then you’re just getting the intro trade savings but if you’re not gonna sell the home before the balloon comes and if interest rates have skyrocketed you could end up with a much much higher mortgage payment.