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With a balloon mortgage, you make monthly payments over the mortgage term, which is typically five, seven, or ten years, and a final installment, or balloon payment, that is significantly larger than the usual monthly payments.
In some cases, you pay only interest on the loan during the mortgage term, and the entire principal is due in the balloon payment.
Many balloon mortgages offer a conversion feature that lets you extend the loan at a new interest rate. For instance, some balloon mortgages convert to a 30-year fixed-rate mortgage at the end of their original term.
You might choose a balloon mortgage if you anticipate being able to refinance at a favorable rate at the end of the term or if you're confident you'll have enough money to pay off the loan in a lump sum. But you may risk losing your home when the balloon payment is due if you can afford to buy the home only because of the comparatively smaller monthly payments that may be available with a balloon mortgage.
A real estate loan with monthly payments as if the loan would be paid in full over a period of time,usually 30 years,but the entire principal balance is due in a much shorter time, usually 5 or 7 years.This is a method for lenders to offer fixed-rate mortgages at rates very competitive with adjustable-rate mortgages,but without the risk that interest rates will rise dramatically in 6 to 10 years or longer, leaving the lender with a low-interest-rate investment in a high-return world. Balloon mortgages are usually quoted as something similar to “6.5 percent interest on a 30-year am [short for amortization] with 5-year balloon.”Also called partially amortized loan.
A mortgage that is payable in full after a period that is shorter than the term.
In the 1920s most balloon loans were interest-only—the borrower paid interest but no principal. At maturity, usually five or 10 years, the balloon that had to be repaid was equal to the original loan amount. The balloon loans offered today, in contrast, calculate payments on a 30-year amortization schedule, so there is some principal reduction. Assuming a rate of 6.5%, for example, a $100,000 loan would have a balance remaining at the end of the fifth year of $93,611.
Comparing a Balloon Mortgage to an ARM: It is useful to compare five and seven-year balloons with ARMs that have the same initial rate periods. Both offer a rate in the early years below that available on a fixed-rate mortgage, and both carry a risk of higher rates later on. But there are some important differences.
Favoring the Balloon:
• Balloon loans are much simpler to understand and therefore easier to shop for.
• The interest rate on a five-year or seven-year balloon is typi- cally lower than that on a 5/1 or 7/1 ARM.
Favoring the ARM:
• The risk of a substantial rate increase after five or seven years is greater on the balloon. The balloon must be refinanced at the prevailing market rate, whereas a rate increase on most five- and seven-year ARMs is limited by rate caps.
• Borrowers with five- or seven-year balloons incur refinancing costs at term, whereas borrowers with 5/1 or 7/1 ARMs don't unless they elect to refinance.
• Borrowers who are having payment problems may find it dif- ficult to refinance balloons. The balloon contract allows lenders to decline to refinance if the borrower has missed a single payment in the prior year. This is not a problem with ARMs, which need not be refinanced.
• Borrowers may find it difficult to refinance balloons if interest rates have spiked. The balloon contract allows lenders to
decline to refinance if current market rates are more than 5% higher than the rate on the balloon.