Balloon mortgage: is it right for you?
A balloon mortgage can be a great option for certain borrowers. Get all the basics here, from what it is to how it works and who should consider one!
The basics of a balloon mortgage explained
Are you on the hunt for your dream home but concerned about managing a large majority of costs? If so, consider a balloon mortgage as an option.
We’ll break down the ins and outs of a balloon mortgage so that you can decide whether they suit your situation. So let’s go!
What is a balloon mortgage and how does it work?
Terms like Balloon mortgage can sound dangerous, so many dismiss the possibility altogether.
In short, a balloon mortgage is a loan in which you pay only the interest for 5 to 7 years. After that period, the mortgage principal must be paid at once.
At first look, it may seem weird, but there is a lot to consider and some situations and options in which a balloon mortgage can work.
For example, you can normally pay the principal once or refinance with the lender. Combined with low-interest rates, it can be a good option for saving.
We will cover this later with more details and options you can choose. Let’s check the main pros and cons of a balloon mortgage!
- Affordable initial amount;
- Relatively low-interest rates;
- You can buy the home earlier;
- Possibly future refinancing.
- Higher foreclosure risk;
- Huge payment at once;
- Hard to find lenders that offer;
- Not so easy to refinance.
Types of balloon mortgages
Although they have short 5 to 7-year terms and a lump sum payment in common, balloon mortgages can differ in what that payment includes.
You can enjoy interest-only, the traditional balloon payment, or no payments during the terms.
See next how works the main types of balloon mortgages.
Balloon mortgages are often called “interest-only mortgages” because of this payment modality.
When contracting this, borrowers will pay only the interest during a pre-established period.
Once over, the loan becomes due, and the remaining balance must be paid in a lump sum.
In this modality, the first period comes with monthly payments based on a typical long-term mortgage.
You will pay interest and principal during the 5 or 7-year terms.
Once the term is finished, you will owe the remaining balance, which must be paid in a lump sum.
It comes with higher monthly payments but a lower amount at the end.
In this type, you will have the lower terms, in which you make no payments. During this time, it will accrue interest at an established rate.
When the term ends, the borrower must pay interest and principal with a lump sum.
How to get a balloon mortgage?
Because of the risks involved, finding a balloon mortgage is not so easy nowadays. There are fewer lenders on the marketing offering them.
They’re possibly easier to find for commercial purposes, although still under very specific situations.
If you still want to get one, you’ll have to take some time to find one.
Contacting your bank or lender who already has some relationship may be a better possibility.
How do you pay off a balloon mortgage?
There are some ways you can pay off a balloon mortgage! Check some below!
Investments or savings
The first and primary way to pay a balloon mortgage you should hardly consider before getting one is with your savings.
It’s the less risky way to get this kind of loan if you’re certain of having the total amount of the principal when the terms are over.
Selling the property
Selling the property can be an alternative! Many borrowers get a balloon mortgage intending not to stay with the house for a long time.
It becomes a way of investing but is also risky because it depends on the real estate market humor.
Refinancing the amount
At last, you can try to refinance the amount due at the end of the terms. Normally a home equity of at least 20% and a good credit score is required.
Also, remember that refinancing will come with possibly higher interest rates and monthly payments you must be prepared to deal with.
Finally, you must be aware that there are risks involved!
Especially if you experience some financial emergency during the period and lose part of your home equity
Should you consider getting a balloon mortgage?
You must consider that a balloon mortgage brings more risks. Most of that is because of the lump sum payment and foreclosing.
Many buyers may be attracted because of no up-front payments, although this may not be the best solution for their needs.
It can be best enjoyed by buyers who don’t intend to stay too much in the home. Selling the property means benefiting from relatively lower rates.
They’re still most common for commercial purposes because of lower monthly payments and lower overall costs than 30-year term loans.
If you still intend to borrow one, you will notice that it is not so common to find it on the market for a first home.
Alternatives to a balloon mortgage
Because of its characteristics and risks for both lender and borrower, it isn’t easy to find a balloon mortgage for primary homes.
There is so much in the game and the possibility of getting into hard times by not honoring commitments. However, lower upfront costs are attractive.
There are more options with lower risks and more conditions involved. Government-backed loans commonly require low or no down payments.
For first-time homebuyers, a balloon mortgage is risky and hard to find. If it’s your case, consider contacting a lender and seeing more long-term options!
Lastly, to help you understand more about mortgages, check out what is a reverse mortgage and its pros and cons.
About the author / Luis Felipe Regueira
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