There is a lot of talk lately about balloon mortgages. How is the consumer to separate the fact from the hype? The interest rates look good, but whats the catch? Lets start with some facts about balloon mortgages, in plain English. Then well discuss how they can be to your advantage.
Balloon mortgages are essentially a mortgage which must be paid in full at the end of the term. Over the course of the mortgage, you will pay a regular payment based on a typical amortization schedule. Then, as the mortgage term ends, the full amount comes due. The final payment you make is called the balloon payment. This payment is essentially the full balance of the mortgage loan.
So, why would you even consider this kind of mortgage? Isnt it a huge gamble? Not necessarily. Balloon mortgages can be an excellent choice if you are looking both for a lower interest rate and are likely to be in the home for a defined period. What if you decide to stay in the home you originally intended to sell? You can also refinance when the mortgage comes due.
Lets look at a scenario. If your company typically moves you from one workplace to another, at a regular and predictable schedule, then a balloon mortgage can work for you. Youll get the lower interest rate up front, and the trick is to time the end of your mortgage with the time in which you would typically sell your home! Then you can easily make your final balloon payment with the proceeds from your home, rather than have to refinance.
Balloon mortgages are generally available for similar time periods as other mortgages. You will likely be looking at a term of either 5 years or 7 years. As a result, these loans are frequently described in financial jargon as 5/25 or 7/23. However, dont count out balloon mortgages if you need a longer or shorter term. You can get terms as short as 3 years or as long as 10.
Whats the difference between a balloon mortgage and your typical ARM (adjustable rate mortgage)? Typically, an ARM will adjust the interest rate on either a semi-annual or annual basis. If interest rates are going up, your rate will be going up regularly too. However, a balloon mortgage will normally only be subject to an interest rate adjustment once after the initial rate is set. Another plus of a balloon mortgage is those lower initial interest rates. Based on how the rates are calculated for balloon mortgages, you can sometime save as much as one or more percent.
However, there are disadvantages. With the typical ARM you can generally negotiate another mortgage with the same lender when the mortgage term is over without much difficulty. With a balloon mortgage, you could be making your refinancing process more challenging and costly. If interest rates on mortgages rise significantly, you could be setting yourself up for additional costs and potential problems. If rates rise more than 5 percent above the balloon interest rate, you could be required to re-qualify and have the home reappraised. This can cost you money and put the new mortgage in jeopardy if the appraised value is less than expected.
Having said that, it never hurts to comparison shop. Certainly, its worth getting pricing on a balloon mortgage and an ARM mortgage at the same time. This gives you the opportunity to compare the options available to you and decide what is best in your situation.
So, youve decided to get a balloon mortgage? How do you do this? You will proceed exactly as you would for any other mortgage. You are still shopping for your best options and you should be asking a similar set of questions as you would ask for any mortgage:
- “Whats the interest rate?”
- “When will the balance come due?”
- “What kind of refinance options are available to me?”
- “How can my refinance options be lost or forfeited and under what conditions?” (If a refinance option is included)
- “Will I have to re-qualify for a mortgage when the balance comes due?”