A balloon mortgage allows you to enjoy low monthly payments for several years — with a big catch. Your final payment amount “balloons,” which could result in a bill that is significantly more than what you have been paying. If you understand the risks and unusual features of a balloon mortgage, this loan type can make sense. Still, it’s best to go in with a plan for how you’ll manage the hefty final payment.
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What is a balloon payment mortgage?
Short-term loans known as balloon mortgages have a set number of initial fixed payments followed by a single, lump-sum payment at the end. Because it’s frequently at least twice as large as the prior payments, that one-time payment is known as a balloon payment and leaves many borrowers with a final bill for tens of thousands of dollars (or more).
These days, it’s difficult to find a balloon payment mortgage for a residential property, mostly because these loans don’t adhere to qualified mortgage (QM) guidelines. Certain characteristics of non-QM loans are known to raise the risk of mortgage default, which can have an effect not only on individual borrowers but also on the mortgage market and the economy as a whole. Congress and the Consumer Financial Protection Bureau (CFPB) created the regulations governing QM loans in reaction to the world financial crisis that occurred in 2007 and 2008.
How to calculate a balloon payment
Lenders typically use one of two methods to determine the low, fixed-rate payments that you will make for the majority of the loan term:
- Amortization over a period that doesn’t match your loan term. Even though your actual loan term may only be 15 years, your lender may still compute your fixed payments as though it were a 30-year loan. You can continue to make these manageable payments for a while, but your balloon payment will be the remaining balance at the end of the loan term.
→ This kind of balloon mortgage is occasionally called a “X due in Y” mortgage (e.g., “30 due in 15”). “X” is the amortization period and “Y” is the loan term.
- Interest-only payments. The only amount you have to pay each month is what the interest charges will be. This means that until you reach your balloon payment, your principal balance remains unaltered.
We’ll look at two examples of balloon payments to show how a balloon mortgage is paid back over time: one with interest-only payments and the other with payments that cover both principal and interest.
This balloon payment example has a 10-year term on a $280,000 loan amount with a 6. 80% interest rate, but because the monthly payments are based on an amortization of a 20-year loan, they are significantly smaller than a fully amortized 10-year loan.
| Year | Monthly payment |
|---|---|
| 1 | $1,825 |
| 2 | $1,825 |
| 3 | $1,825 |
| 4 | $1,825 |
| 5 | $1,825 |
| 6 | $1,825 |
| 7 | $1,825 |
| 8 | $1,825 |
| 9 | $1,825 |
| 10 | $1,825 |
| Final balloon payment: | $240,958 |
Since principal and interest are paid on the loan, the balance does not decrease as much as it would if principal and interest were only paid off by the due date.
This five-year balloon payment example uses the same $280,000 loan amount and 6.80% rate.
| Year | Monthly payment |
|---|---|
| 1 | $1,587 |
| 2 | $1,587 |
| 3 | $1,587 |
| 4 | $1,587 |
| 5 | $1,587 |
| Final balloon payment: | $280,000 |
Because the payments are interest-only, the principal balance doesn’t decrease at all during the five-year term.
What is a Balloon Mortgage Loan? What’s the Benefit?
FAQ
What does 5 year balloon mean?
Why would someone do a balloon mortgage?
Is it a good idea to get a balloon loan?
What are the drawbacks of a balloon loan?
What is a balloon mortgage?
You can make these affordable payments for a while, but whatever outstanding balance is left when you reach the end of your loan term will be your balloon payment amount. → This type of balloon mortgage is sometimes referred to as an “X due in Y” mortgage (for example, “30 due in 15”). “X” is the amortization period and “Y” is the loan term.
Are balloon mortgages risky?
Balloon mortgages can be risky for borrowers, as they may struggle to make the large balloon payment at the end of the loan term. Other mortgage options, such as conventional loans or FHA loans, may be better suited for those looking for lower monthly payments without the risk of a large balloon payment.
How do balloon loans work?
With a balloon mortgage, you make small monthly payments then pay a large lump sum at the end of your loan term. Depending on your lender, you’ll either make interest-only monthly payments or payments toward the interest and a small percentage of your principal. Are balloon loans a good idea?
What is an interest-only balloon mortgage?
An interest-only balloon mortgage means the borrower makes monthly payments only on the interest their loan is accruing. At the end of the loan term, they just have to pay back the principal. Borrowers tend to build equity on their house more slowly with this type of balloon mortgage.