When you start looking at mortgages, all the different options can be confusing. A balloon mortgage is a specific type of home loan that requires you to make a large payment — hence, the name “balloon” — after a relatively short period of time.
Don’t be left out in the cold when your balloon payment comes due — make saving to pay it off part of your financial plan. Keep reading to learn everything you need to know if you’re facing a balloon payment — including what options you have regarding how to make this mortgage payment.
What Is a Balloon Payment?
A balloon payment is a payment at the end of a loan term that is “larger than usual,” according to the Consumer Financial Protection Bureau. The payments during the first years of this type of mortgage are lower, and they are followed by a single, large payment due at the end of the loan. The balloon payment typically pays off the loan.
A balloon mortgage’s monthly payments, like a traditional mortgage’s, are based on the principal and interest’s amortization over 30 years. After a shorter period of time, however — typically five to seven years — the remaining, unpaid, principal balance is payable in full.
In other words, these loans have a 30-year amortization schedule with a balloon payment after five to seven years. Some balloon mortgages have a reset feature: When the loan term ends and the balloon payment is due, you can reset the loan to its original terms. Keep in mind, however, that you’ll still have another balloon payment due in five to seven years.
Related: How to Get the Best Mortgage Rate
What Happens When the Balloon Payment Is Due?
When your balloon payment is due, you have two choices to pay it off: You can take out another mortgage for the amount of the balloon payment or you can sell your home and use the proceeds to pay it off.
If you take out another mortgage, you will need to apply — and qualify — for one that is at least equal to the amount of your balloon payment. Points and closing costs might be associated with the mortgage you get, and your new amortization schedule will likely be over 30 years, so you’ll be essentially starting over.
If you sell your home to make the balloon payment, start the process early. It could take several months to sell your place, and you will have to find a new home, too. In addition, you’ll need to save enough money for a down payment on a new home.
Balloon Mortgage Risks
A balloon mortgage carries risks that other types of mortgages don’t. Your property value could fall, your financial situation could deteriorate, or you might not be able to sell your home or refinance your mortgage before the balloon payment comes due. Make every mortgage payment on time and keep your credit score high to reduce the risk that you won’t qualify for a new mortgage when your balloon payment is on the horizon.
The interest rate could also rise during your loan term, which means you’d have to refinance your mortgage at a higher rate to make the balloon payment. With mortgage rates as low as they are today, this is a serious risk.
When low interest rates are available, a fixed-rate mortgage is probably your best bet. If you are certain your income will rise significantly over the next few years, you can get an adjustable rate mortgage that converts to a fixed rate in five to 10 years.
If you have a mortgage with a balloon payment, have a plan for making the payment. Understand what your options are, and start the process early to refinance or sell your home.