Advantages and Disadvantages of a Balloon Mortgage

There are a lot of home mortgage options available today, and it is important to be aware of them all in order to choose the one most suitable for you and to be sure that you are doing the best thing possible. One of the available options is the so-called “balloon mortgage”, and in this article we shall discuss this one in terms of its main concepts and possible cons and pros of choosing it among the other options available.

So what is a balloon mortgage and how does it work? A balloon mortgage has a lot in common with a fixed rate mortgage. The principles of calculating monthly payments are actually the same: monthly payment will be calculated as the amount required to repay the whole loan over a period of 30 years. But here comes the principal difference: after a certain period, which will normally be 5-7 years, you’ll have to repay the whole outstanding balance at once. This is called “a balloon payment”, or simply “a balloon”, and this is what the term “balloon mortgage” originates from.

At first sight this scheme seems totally inconvenient. It is very unlikely that a borrower will have enough money to repay that huge amount of outstanding balance at once and at that exact moment, and that may cause serious problems, if the borrower will still be living in the house by the moment a balloon becomes due for payment.

In fact, the solution here is refinancing, which will allow you to get the current market rate. Some people say that in this regard the balloon payment is in a way similar to an adjustable rate mortgage (ARM) – that is because you get a set period of paying a fixed rate and after that a period when the rate can be adjusted.

Now let’s look a bit deeper into the matter and try to compare a balloon mortgage with an ARM. In case of a balloon mortgage you need to repay the entire loan after 7 years, which is normally done by means of refinancing, after which you get a different rate for the new loan that will be adjusted. ARM may be a bit more difficult to handle, because the rate adjustment is provided for in the contract. On the other hand, an ARM is often a done deal, which makes things easier, because you are locked into a contract. With a balloon mortgage you get additional refinancing costs, which is surely a negative factor for the borrower. Besides, the rate you get after refinancing often hurts your credit a little. But the main factor is that with ARM you get protection against interest explosions, which is not the case for a refinanced balloon mortgage – if the refinancing time falls on a period of a high rate rise, you are left totally unprotected against it. For justice’ sake, though, it should be noted that this is a very rare case.

All in all you should do decide for yourself, which option suits your needs best. A balloon mortgage can be a great option if you do not plan to live in the house for long, i.e. for more than 5-7 years, because in this case you get a price advantage with a balloon mortgage. But in case you are unsure about where you will be living in 7 years, it would be wise to abstain from the balloon mortgage option to avoid the risk of ending up with a huge balloon payment and costs of refinancing.