Balloon Mortgage

A Balloon Mortgage is a mortgage that requires the principal to be paid in full before the mortgage comes to full term. Balloon Mortgages get their name because a large payment "balloons up" in the middle of the term.

Historically, balloon mortgages have been interest-only. The borrower paid only the interest on the loan, and when the loan payment was due they would pay the entire amount of principal. Today, balloon mortgages are typically calculated based on a 30-year amortization schedule, which allows you to pay down some of the principal.

The recent boom in property values has made the balloon mortgage increasingly common. With interest rates on balloon mortgages being substantially less than a standard 30-year fixed (or even an ARM), buyers can afford the monthly payments on a much more expensive piece of property. Because these borrowers are certain that the property will increase in value (hopefully by quite a bit), their plan is to simply sell the house to make the balloon payment. Of course, nothing in life is certain; should your property value decrease, you will be faced with paying the difference when you sell. If you can't afford to sell when the balloon payment comes due, or you don't want to, you will have to refinance in some way.

Those that refinance their balloon mortgage when the principal payment is due face several uncertanties. What will the interest rates be in 7 years? How much will the property be worth? Will the cost of refinancing be offset by the savings in monthly payments?

In this respect, a balloon mortgage is much like an ARM. Used wisely, it can be a powerful investment tool. But just like any other investment, with greater potential for reward comes greater risks. I strongly advise mortgage shoppers to discuss the pros and cons of the riskier mortgages with a trained financial professional, and to be as well educated and prepared as possible.