You’ve found your dream house online, but now it’s time to figure out how you’ll pay for it. If the idea of postponing mortgage payments sounds like a great idea, a balloon mortgage might be a good option for you. Just like with any type of home financing, balloon mortgages have pros and cons. Here’s what you need to know.
What is a balloon mortgage?
Balloon mortgages are loans that require low or no payments for usually five to seven years, though some terms may be as short as two years. During this period, borrowers’ monthly payments may be interest-only, making it much more affordable to buy a home in the short term. After that time is up, borrowers pay the remaining loan balance in one lump sum, hence the term, ‘balloon mortgage’.
Balloon mortgages are not the same thing as an adjustable-rate mortgage. However, both can be great alternatives to fixed-rate mortgages, providing financially savvy buyers greater flexibility.
Who are balloon mortgages best for?
- Individuals with guaranteed increases in income within the next few years
- Individuals who routinely receive large bonuses
- Investors looking to cash in on a hot area with rising home values
- Home buyers looking for an affordable, short-term housing option
5 Benefits of balloon mortgages
1. Lower initial payments
For borrowers who expect a substantial rise in income but have little financial wiggle room at the time of closing, a balloon mortgage’s low initial payment period can be a relief.
These low, interest-only payments (or lack of payment altogether) can be great for buyers looking to live in a home for five years or less. Using a balloon mortgage is also a common strategy used when moving to another state without selling your old home first.
2. Lower interest rates
Balloon mortgages are available at both fixed and adjustable rates, often up to 2% lower than a traditional mortgage. This makes the initial monthly interest-only payment even more manageable.
If you’re concerned about high mortgage rates and think a balloon mortgage could be beneficial, your mortgage lender can outline all of the potential costs of each type of mortgage to help you make a more informed decision.
3. Potential for property appreciation
Balloon mortgages are attractive for investors making a bet on a market that is poised to explode in value with little money down. These types of mortgages allow you to purchase before the secret is out but for a low cost of entry.
4. More available money
If you need time to pay down other debt, build up your savings, or work on your credit score, a balloon mortgage can help. Your money is free to work for you during the initial repayment period instead of being committed to a large mortgage payment upfront.
5. No prepayment penalties
If your situation changes and you have the opportunity to pay off your principal (or pay it down) early, you can do so without penalty.
4 Balloon mortgage drawbacks
Delaying monthly mortgage payments may sound like a great idea but there are serious issues can arise with a balloon mortgage. Here are four cons to consider.
1. Large lump-sum payment
The biggest challenge of a balloon mortgage is the lump-sum payment due after five to seven years. It’s easy to sign the paperwork and kick that financial can down the road, but many people struggle when the final payment looms large.
2. Refinancing risks
Newbie investors and first-time homeowners may take out a balloon mortgage with plans to refinance into a more traditional loan before the balloon payment is due but getting approved is not always a given.
3. Interest really adds up
As homeowners with adjustable-rate traditional mortgages learned during the steady rate hikes of 2022, even a relatively small increase in the interest rate can make a big difference in terms of affordability. In 2020, mortgage rates hovered around 2%, but in 2023, they’re north of 6%. On a $250,000 loan, that’s roughly a $600 difference in monthly interest alone.
4. Strict deadline to sell
If you plan to live in your home for less than five years before selling and moving away, what happens if the market cools just in time for your balloon payment due date? This is not uncommon, and it can result in default or foreclosure if you are not able to sell your home or make the balloon payment.
Is a balloon mortgage right for you?
Home buyers looking for creative ways to afford a home have more options than might realize. Balloon mortgages are a mixed bag of opportunities and challenges for homebuyers. The lower payments and interest rates might be attractive, but the risks are important to consider.
Pick your mortgage with as much care as you choose your realtor. Talk with a mortgage specialist or financial advisor and carefully consider your overall financial goals and risk tolerance before committing to this type of mortgage.