The word “balloon” typically calls to mind parties and celebrations. However, a balloon mortgage can be a stressful affair for some borrowers. A balloon mortgage is a type of loan, generally used by real estate investors, that involves a large payment at the end of the term.
Depending on the loan structure, balloon mortgages may involve just a single lump-sum payment (including interest) at the end of the term, they may be interest-only loans, or they may partially amortize during the loan term with a sizable final payment. Like a balloon, these mortgages start out small, but inflate to require a hefty closing charge.
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How Does a Balloon Mortgage Work?
Balloon mortgages in their traditional form are no longer permitted after their popularity in the early 2000s contributed to the financial crisis of 2008. Updates to the financial regulatory system in 2010 only permit a payment more than twice the amount of earlier scheduled payments in special circumstances. As such, many banks no longer offer these types of mortgage loans. However, private hard money lenders do still offer balloon loans, typically to house flippers or other commercial real estate investors.
Like a traditional loan, a balloon loan borrower will make payments (usually monthly) on the loan over a set period of time. Typically, the term is much shorter than traditional 30- or 15-year fixed rate mortgages. Some loans, if intended for house flippers, might have a mortgage term of only a few months.
Other individuals might use a balloon loan with a 5- to 7-year term to help get them into a home they might otherwise not be able to afford. At the end of the term, the remaining loan balance is due. It is generally assumed that the borrower will sell the home at the end of the term to pay the balance they owe or refinance the loan to avoid the balloon payment.
Interest on a balloon payment mortgage can vary widely. Since the loan term is comparatively shorter than a traditional mortgage with a fixed interest rate, interest payments can be lower. However, since these loans are most frequently offered by hard money lenders, interest rates are not regulated. Hard money loans are often thought of as high-risk, which means that lenders may charge higher interest rates to protect their investment.
There are different balloon mortgage loan structures that borrowers can choose from depending on their unique needs. Some of the most popular include:
- No monthly payments, but a single lump-sum balloon payment due at the end of the loan term, including the loan amount and all of the interest.
- Monthly payments of interest only with the full loan value due at the end of the term.
- Partial amortization, meaning that interest is paid monthly along with a small amount that goes towards the principal. At the end of the term, a large sum is due to account for the remaining balance you owe.
An online mortgage calculator can help give a rough idea for monthly payments based on the type of structure you choose and the value of your property.
What Are Balloon Mortgage Rates?
Currently, mortgage rates for a traditional 15- or 30-year fixed-rate loan are a little below 4%. A 15-year adjustable rate mortgage and a 5/1 adjustable rate mortgage (where interest is fixed for the first 5 years of the loan and then it has an adjustable rate for the duration) presently have interest rates hovering around 3%.
Balloon mortgage rates are also generally in the 3% range, though some hard money lenders may charge up to double the market rate depending on your financial situation and their preferred lending policies. Hard money lenders may also charge 1-2 points on your loan as an origination fee. Each point is equivalent to 1% of the loan amount. Consult an online mortgage calculator for real-time rate information.
For the most part, a balloon mortgage will have a lower interest rate than a conventional mortgage. Balloon mortgage rates are about the same as an adjustable-rate mortgage without any ambiguity concerning future payment. Whether the lower monthly payments are worth it will depend on your personal plans and tolerance for risk.
Pros of Balloon Mortgages
Though having a hefty balloon payment on the horizon is certainly daunting, balloon mortgages do have certain advantages that may outweigh the risks, contingent on your individual situation and goals.
- An eye towards the future: In most circumstances, your income and savings will grow as you advance in your career. A balloon mortgage can help you get into a long-term home at a price you can afford now. This can also be helpful for individuals expecting a large inheritance or a trust disbursement before the loan is amortized.
- Flexible structuring: Some individuals with fluctuating pay may have a hard time obtaining a conventional fixed mortgage. A balloon mortgage can help people buy a home, especially those with project-based work or those who receive a small regular salary with a large seasonal bonus.
- Short terms: The abbreviated terms offered by most balloon mortgages are ideal for homeowners who only intend to stay a short while or for fix and flip real estate investors who want to pay the lowest rate while they renovate.
- Lower interest rates: Quite simply, a borrower will save on interest with a lower monthly payment rate.
- Low or no down payment: Most balloon mortgages require a lower down payment than their traditional counterparts, which is ideal for those without savings. This can also be helpful for house flippers whose assets are tied up in another project.
- Simplified qualification: Because of the unusual structuring and the fact that many traditional banks no longer offer balloon loans, it is easier to qualify for this type of financing, especially for those who don’t meet standard requirements, like a good credit score and strong financial history.
- The ability to refinance: A balloon mortgage isn’t permanent. You always maintain the option to refinance the loan at any point. In fact, many individuals seek a balloon loan for the lower rates with a plan to refinance before the term is up to avoid the large balloon payment. Of course, you never know what the interest rates will be at that point or whether unexpected events might impact your financial situation.
Cons of Balloon Mortgages
- The big payment: Obviously, the imminent balloon payment hanging over your head can big difficult. Though you may expect to save for it or receive a windfall before the loan reaches amortization, you never know what complications tomorrow may bring.
- Refinancing difficulty: Again, uncertainty about the future plays a big role in a balloon mortgage. Though you may plan on refinancing, you don’t know if rates will go up significantly. And you don’t know that you’ll be qualified to refinance when the time comes. Also, the value of your home may depreciate and a lender may not be willing to refinance a home with negative equity. In fact, that’s what’s partially to blame for so many foreclosures during the recent financial crisis.
- Flipping challenges: If you’ve obtained a balloon mortgage with the goal of flipping an investment property, your ability to make the final balloon payment may be hindered by a number of factors, such as construction delays, unexpected repairs, or a change in market conditions.
- Short terms: Though this may be a benefit for some, it can be a hindrance for others, since it allows less time to make the money to pay your balloon charge when the loan matures.
- Difficult to find: Because of current regulations, it can be hard to find a balloon lender. Though hard money lenders do offer these types of mortgages, some individuals are averse to working with them because of the lack of oversight in the industry. Most hard money lenders are reputable, but there definitely are some who employ predatory practices.
- Risk: No investor is clairvoyant. If something comes up and you’re not able to pay the final balloon payment in the short timeframe allowed or refinance your loan, you’ll be forced by your current lender to sell your home or default on the mortgage, which will significantly impact your credit score and your financial future.
When To Consider Getting A Balloon Mortgage
A balloon mortgage may be a viable choice in specific conditions.
- Fix and flip: If your intention is to purchase real estate, renovate, and sell it quickly for a profit, a balloon mortgage could be the ideal financing method. It will save you the most money on monthly mortgage payments.
- Financial windfall: If you are expecting a large payout in the future, but don’t currently have the money to make pricey monthly mortgage payments, a balloon mortgage may be right for you. However, you would have to be rather certain about the money coming to you within an exact timeframe (e.g., a scheduled trust disbursement).
- Short-term living situation: Individuals who move frequently for job assignments might find a balloon mortgage worthwhile. If you know you will only be in a home for a specified stint, a balloon loan can save you money during the amortization period.
- Career growth: Some jobs offer programs that outline a very specific path for career development, including an upward compensation scale. If you are committed to such a program, a balloon loan may be able to get you into your ideal home sooner than you may otherwise be able to afford.
- Refinancing plans: A balloon loan offers a low monthly payment that can open the door for many to obtain a mortgage on a home for which they might not otherwise qualify. If you use a balloon loan in this way and plan to refinance before the final balloon payment is due, it can work to your advantage. However, in this situation you will need to manage the risk of uncertainty – Many things can change during the amortization period, including the home value, interest rates, and your personal financial situation.
Balloon Mortgage Lenders
When you begin looking for a mortgage with a balloon payment, you may wonder, “Do balloon mortgages still exist?” They do, though they are not as commonplace as they once were. A good place to start is online. By looking up “balloon mortgage calculator,” you will find a number of sites that can give you an idea of what your monthly payments would be and what kind of a balloon payment you would owe at the close of the loan. These sites will also refer you to balloon lenders who may be willing to work with you given the financial parameters you entered into the calculator.
Another place to look for a balloon loan is with hard money lenders. There are lenders that operate both nationally and locally. A local hard money lender may be especially helpful in providing guidance regarding the regional market climate. Before working with any hard money lender, be sure to check references and reviews to guarantee you’re not being taken advantage of.
Finally, if aspects of a balloon loan appeal to you, you can visit a more traditional bank or contact an alternative online lender to see what different types of loan structures they may be able to offer to meet your needs. Often, adjustable-rate mortgages provide similar benefits as balloon loans without some of the drawbacks.
Final Word: Balloon Mortgages
Balloon mortgages are scary, but they can be a beneficial means of financing in the right situation. These loans make the most sense for house flippers, individuals who know they’ll only be living in a house for a set time, and people expecting a large future financial gain. With comparatively low interest rates and flexible structuring, balloon loans can help people who otherwise might not qualify for a conventional mortgage.
Since these loans are most commonly available through hard money investors, it’s wise to vet the lender before engaging in any type of financial contract. An online mortgage calculator can help you get an idea for competitive and current interest rates and the type of mortgage that will best fit your needs before you approach a lender.
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