How Does a Balloon Loan Work for a Mortgage?

How a Regular Mortgage is Paid Over Time

Most mortgages are amortized out over a period of 15, 20 or 30 years. If the mortgage is a fixed rate, you pay a set amount over that period of time and at the end of that time your mortgage is paid off and you don't owe any more for it. If you have an adjustable rate mortgage, your payment is fixed for a certain amount of time and them will adjust up or down depending on the market at that time. However, you still pay for the amount of time you took out the mortgage for and at the end of that period of time, the mortgage is paid in full.

When you have a balloon mortgage, it is still amortized over a period of 15, 20 or 30 years. Balloon mortgages can be fixed or adjustable rate. However, you will make your payment for a certain amount of years and then the balance will be due. Most balloon mortgages come due in 2, 5 and 10 years. Since you have been making amortized payments for a shorter period of time, the final payment will be very large compared to your regular monthly payments. For example, you buy a house and mortgage $100,000.00 at the going interest rate. You have a five year balloon mortgage, amortized over 30 years. Your payment is based on the 30 years, so let's say it's about $700.00 per month. You loan is called due at the end of the five years and you have only paid it down to $98,000.00 because most of the payments have gone toward the interest. You will have to pay the $98,000.00 at the end of the five years.

People use balloon mortgages for many different reasons. One is if you don't intend on keeping the property for more than a couple of years. You may get a better interest rate and have intentions on buying the house, fixing it up and selling it. Many private investors use balloon mortgages when they loan money because they don't want their money tied up for 30 years. Another reason could be that you are sure you will be in a better position to qualify or will have more money to put down in 5 or 10 years and you will refinance it into a 30 year fixed rate. Sometimes if your qualifications are less than perfect the bank doesn't want to take a long term chance on you and they will offer you a balloon mortgage instead of a fully amortized loan.

You should start to inquire about your options at least a year before your balloon becomes due. You may want to finance the balance into a first mortgage or if you know you won't qualify for a mortgage, you may want to put the property up for sale. You can check with the person or company that currently has your loan and see if they would consider extending the balloon date. Just don't wait too long and then find out you have no options. Most likely, if you don't have that final payment when due, the mortgage holder can foreclose on you.