What is a Balloon Mortgage and How Does it Work?

A balloon mortgage is one type of mortgage loan option which is different from the many loan products available on the market. It is a mortgage product that generally has a shorter repayment term, for example, a term of just 5 years as opposed to a conventional mortgage loan with a repayment term of 15 or 30 years.

A balloon mortgage gets its name from the structure of the loan. Each month borrowers will make a mortgage payment to the lender, however, this payment will generally only include loan interest and not any loan principal. At the end of the term of the loan, the full amount of the loan will come do in one payment, known as the balloon payment. The homeowner than has the option to either pay the reminder of the loan in full, to refinance the loan or to sell the home to satisfy the loan due.

For example, if you took out a balloon mortgage with a term of 5 years (also known as a “five-year balloon mortgage”), you will have 5 years where your monthly mortgage payment will be at a fixed interest rate, and your payment will be low as it will include only interest due on the total loan. With balloon mortgages, the interest rate is often lower than the rate you’ll qualify for with a conventional mortgage loan, which makes them an attractive option for many prospective homebuyers. At the end of the 5-year term in our example above, one large payment equal to the reminder of the balance of the loan will be due. This is known as the “balloon payment”.

What are the advantages of a balloon mortgage?

One of the biggest advantages of a balloon mortgage over more conventional mortgage loan terms is that they often have a lower interest rate than some other mortgage loan products. Balloon mortgages are generally advantageous for buyers who are very likely to sell their home before the balloon payment becomes due, or those with the investment experience and knowledge to leverage the money they will save each month towards paying off the end balloon payment.

What are the disadvantages of a balloon mortgage?

One of the biggest disadvantages however, it that the final balloon payment is generally very substantial and an amount that the average homeowner may not have access to in savings. Although you can refinance your mortgage loan at the end of the term, you will be taking a gamble on whether or not the interest rates in a few years time will be as low as those available to be locked-in today for a 15 or 30 year mortgage loan term.