In this article, we will discuss and cover what balloon mortgages are and how it works. Balloon mortgages are short-term loans that have fixed monthly payments, usually based on a 30-year fully amortizing schedule. Balloon loans are for commercial loans only and do not apply to residential mortgages. After the 2008 housing meltdown and subprime mortgage collapse, federal mortgage regulators banned balloon mortgages for owner occupant homes. It is only available for investment properties and commercial loans. In this article, we will cover and discuss how ballon mortgage work.
Terms Of Balloon Mortgages
Here is how balloon term loans work:
- Normally amortized over 30 years
- Only for commercial mortgages
- Only good for 3, 5, 7, or 10 years
- After the term is up, the whole balance of the loan is due
- Up to the commercial lender whether they are going to renew the loan or not
How Do Balloon Mortgages Work
Balloon mortgage products frequently offer a refinancing option at maturity. This option allows balloon borrowers to convert the loan to a fixed-rate mortgage or may restart another new balloon mortgage. Some lenders do not require the borrower to requalify for the loan or for the property to be approved again. However, some lenders require that the borrower and the property meet current underwriting guidelines. The interest rate on the new loan will be based on the current rate in effect at the time of conversion.
Balloon Mortgages Benefit Real Estate Investors
Balloon-type financing is typically used by real estate investors who are planning to sell their properties before the balloon payment becomes due. This type of financing is a great commercial loan program for real estate investors looking for short-term financing. In any event, the typical goal is to sell the property before the balloon payment becomes due. As with other nontraditional mortgage products, real estate investors take advantage of the initial low-interest rate. Investors then move on before the consequences take effect.
Advantages And Disadvantages of Balloon Mortgages
The obvious advantages of a balloon mortgage are its initially low rate of interest and low monthly payments. The disadvantage is that at the end of the term, the borrowers need to come up with a lump sum and the loan balance is due.
The entire balance needs to be paid by the following:
- selling property
- refinancing
- securing a new loan
- liquidating other investments to pay the mortgage note
If real estate investors cannot come up with the entire balloon mortgage loan balance at expiration, the lender can start foreclosure proceedings. Commercial foreclosures are rather quick and easy and not long like residential foreclosures. Today, I do not know of any residential mortgage lenders that offer balloon mortgages. Balloon mortgages are normally offered by commercial lenders.
Adjustable-Rate Mortgages
Adjustable Rate Mortgages are offered for both residential and commercial loans. Adjustable Rate Mortgages are also referred to as ARMs. With ARMs, borrowers are guaranteed a 30 year term loan. However, the way ARMs work is there is an initial fixed-rate period of 3, 5, 7, or 10 years. After the initial fixed-rate period, the mortgage rate will adjust every year for the remaining 30 year mortgage term. The new adjustable mortgage rate depends on a fixed margin rate plus the index. The index may change every year. Margins are the same. For example, if an ARM has a 3 margin, the newly adjusted rate after the fixed-rate period expires will be the 3 margin plus the index for the year. This process is repeated for the term of the adjustable-rate mortgage. ARMs normally have lower interest rates versus 30-year fixed-rate mortgages. ARMs are a great loan program for first-time home buyers or borrowers with higher debt to income ratios.
Risks Associated With Non-Fixed Rate Mortgages
Balloon mortgages are mortgage loans that are amortized over 20 to 30 years. These loans are only good for three, five, seven, or ten years. When the term comes up, the whole balloon loan balance is due. Balloon mortgage loan borrowers need either to pay off the balloon mortgage loan balance in full or need to refinance the loan. However, if the balloon borrower’s credit and/or financial profile has deteriorated, he or she will have a hard time refinancing the balloon mortgage. If that is the case, the balloon mortgage loan lender will demand the note. The note needs to be paid in full if they are not intending on offering a refinance loan. If the borrower cannot get it refinanced, the balloon mortgage lender can proceed with foreclosure proceedings. Many commercial real estate investors faced foreclosure after the 2008 real estate and credit collapse when lending tightened up and balloon mortgage lenders ended up foreclosing on the commercial real estate properties.
April 25, 2022 - 4 min read