Balloon mortgages were once a popular way for homebuyers to lower their monthly payments, but fell out of favor after the 2008 financial crisis. While not as prevalent as they once were balloon mortgages do still exist today. But what exactly are they and are they a good option for today’s homebuyers?
What is a Balloon Mortgage?
A balloon mortgage is a type of mortgage loan that has lower monthly payments for a certain number of years. At the end of the loan term, there is one big payment called a “balloon” that pays off the rest of the loan.
Here’s how they work:
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You make low monthly payments, typically for 5-7 years. These payments are based on a longer amortization period, like 30 years, which means that the payments are lower.
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At the end of the loan term, you must make one large “balloon” payment to pay off the entire remaining loan balance. This final payment can be very high, often tens of thousands of dollars.
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Loan terms are shorter than traditional mortgages, usually 5-10 years. Borrowers often intend to sell or refinance before the balloon payment comes due.
To sum up, balloon mortgages let you make lower monthly payments for a number of years, then one big payment at the end. This structure helps borrowers who need lower payments right now but think their finances will get better later.
Are Balloon Mortgages Still Available?
Yes, some lenders still offer balloon mortgages today. However, they aren’t nearly as common as they were prior to 2008.
After the financial crisis, rules were put in place to cut down on risky lending practices like balloon mortgages. Big banks don’t offer balloon mortgages, but smaller banks, private lenders, and credit unions do. Availability depends on your location and the lender.
So while not as widespread as conventional mortgages, balloon home loans are still alive and kicking today. They occupy a small niche in the current mortgage market.
The Pros and Cons of Balloon Mortgages
Before deciding if a balloon mortgage fits your situation, weigh the pros and cons:
Pros
- Lower monthly payments free up cash flow
- May have quicker approval than traditional mortgages
- Flexibility to finance investment properties
- No prepayment penalties
Cons
- Large balloon payment risks foreclosure if you can’t pay
- Slower equity building compared to traditional loans
- Tougher credit score and down payment requirements
- Overall higher costs due to higher interest rates
For certain borrowers, the lower payments can outweigh the risks of the balloon structure. But for most homeowners today, the cons make balloon mortgages too risky.
Alternatives to Balloon Mortgages
If you need lower monthly payments but want to avoid a balloon loan, consider these options instead:
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FHA Loans: Offer low down payments and credit requirements.
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VA Loans: Provide 100% financing and low rates for veterans.
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USDA Loans: No down payment required, better rates in rural areas.
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ARMs: Adjustable-rate mortgages have lower initial payments but fluctuating rates.
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Longer Mortgage Terms: Opt for a 30 or 40-year term to lower payments.
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Refinancing: You may qualify for better rates/terms by refinancing your current loan.
These alternatives can provide payment relief without the risks of a balloon mortgage.
The Bottom Line
While not as common today, balloon mortgages still exist for borrowers seeking low payments upfront. But for most homebuyers, the massive balloon payment, tough requirements, and higher costs make them too risky.
If you’re looking for lower monthly payments, safer alternatives like government-backed loans or longer mortgage terms can help you achieve affordable homeownership without the complications of a balloon loan. As with any major financial decision, be sure to weigh all your options carefully.
Should you take out a balloon mortgage?
For most people, taking out a balloon payment mortgage is a pretty big risk. Even if you have a plan to refinance or sell before the final payment is due, the market could change and make those options impossible. Then, you’ll be stuck with a very large payment and, if you’re unable to come up with the cash, you could face foreclosure.
How does a balloon mortgage differ from other loans?
In addition to having a lump-sum payment due at the end of the loan term, balloon mortgages differ from other loan types in a few ways:
One significant difference is the type of lenders that provide balloon mortgages. Balloon payment loans are typically offered by small or private lenders and can be reserved for certain types of lending, like construction.
Balloon mortgage lenders establish their own requirements. They can be stricter, requiring higher credit scores and down payment amounts.
However, they can also be looser in other ways, if the lender is catering to a customer base that needs alternatives to standard mortgage qualifications. They may not require the same level of income documentation or may allow you to skip a home appraisal, for example.
Balloon mortgage rates are typically higher than your average 30-year fixed-rate mortgage because lenders are taking on a great deal of risk. In some cases, though, the rates you’re offered may be temporarily lower. If you’re planning to refinance the loan before the balloon payment is due, you’ll still have a large balance and there’s no guarantee mortgage rates will have dropped by then.
Curious where rates are headed? Read our current mortgage rates forecast.
What is a Balloon Mortgage Loan? What’s the Benefit?
FAQ
Do banks still do balloon mortgages?
Most mortgage lenders don’t offer balloon mortgages. They’re best for borrowers with unusual credit and financial circumstances. Getting an adjustable-rate mortgage (ARM) or refinancing are two other ways to get a lower monthly mortgage payment besides a balloon mortgage.
What are the 2 types of balloon mortgages?
Types of Balloon MortgagesFixed-Rate Balloon Mortgage: Interest rate remains constant throughout the loan term. Adjustable-Rate Balloon Mortgage: Interest rate may adjust periodically before the balloon payment is due. Interest-Only Balloon Mortgage:
Why do people avoid balloon mortgages?
You’ll Have to Make or Repay a Big Payment If you don’t have the cash on hand to make the balloon payment, you’ll have to get it. You might do this by refinancing your loan or getting a new loan. House flippers sometimes use balloon mortgages because they plan to sell the home before the balloon payment comes due.
Is a balloon mortgage illegal?
In the business world, these large payments are known as “balloon payments,” and if they are backed by a Deed of Trust, California law has strict rules for the lender who wants to receive a balloon payment on a California note and foreclose on the Deed of Trust if the balloon payment is not paid.