Balloon Mortgages

Gustan Cho Associates

Balloon mortgages are short-term loans that have fixed monthly payments, usually based on a 30-year fully amortizing schedule. Because a 30-year loan cannot fully amortize over the balloon mortgage’s term—which is typically three, five, or seven years—a large balloon payment is required at maturity to repay the remaining principal balance of the loan.

Balloon mortgage products frequently offer a refinancing option at maturity that allows borrowers to convert the loan to a fixed-rate 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 standards. The interest rate on the new loan is based on the current rate in effect at the time of converting.

Balloon-type financing is typically used by people who are planning to sell their homes before the balloon payment becomes due and by 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, these people take advantage of the initial low interest rate and 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 borrower must come up with a lump sum to pay off the loan by refinancing, securing a new loan, or liquidating other investments.

And, because lenders making nonqualified mortgage loans now face greater liability, including the imposition of punitive damages, it is expected that the balloon loan market will significantly decrease.  Today, I do not know of any residential mortgage lenders that offer balloon mortgages.  Balloon mortgages are normally offered by commercial lenders.

Risks With Balloon Mortgages

Balloon mortgages are mortgage loans that are amortized over 20 to 30 years but are only good for three, five, or seven years.  When the term comes up, the whole loan is due.  Balloon mortgage loan borrowers need either to pay off the balloon mortgage loan balance in full or need to refinance the mortgage loan.  However, if the balloon mortgage loan 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 to be paid in full if they are not intending on offering a refinance loan and if the borrower cannot get it refinanced, the balloon mortgage lender can proceed with foreclosure proceedings.  Many commercial real estate investor 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.

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