Balloon Mortgages

Balloon mortgages are short term mortgages with some features of a fixed rate mortgages, albeit marked by a few significant differences. Balloon loans provide a level payment feature during the term of the loan but as opposed to the 30 year fixed rate mortgage, balloon loans do not fully amortize over the original term. So, because such loans don’t fully amortize, at maturity a balance remains which must then paid. The final payment, referred to as a “balloon payment,” can be quite large. At the end of the loan term, the mortgage company usually requires that your loan be paid in full with respect to the remaining principal balance and this can, of course, be accomplished by refinancing. It’s important to mention that balloon payment mortgages are generally more common in commercial real estate than residential real estate.

Balloon mortgages have shorter terms (most are 5-7 years) which give the lender better security against interest rate risk than a 30-year fixed-rate loan, while simultaneously providing the security of a fixed payment and possibly a lower interest rate than a 30-year fully-amortizing fixed-rate loan. Because borrowers may not have the all of the resources to make that big balloon payment at the end of the loan term, a "two-step" mortgage plan may sometimes be employed with balloon payment mortgages. Under the two-step plan, sometimes referred to as a "reset option", the mortgage note "resets" using current market rates and using a fully-amortizing payment schedule. For balloon payment mortgages without a reset option or where the reset option is not available, the expectation is that either the borrower will have sold the property or refinanced the loan by the end of the loan term. This, of course, means that there is a level of refinancing risk.

Balloon mortgages are often confused with Adjustable Rate Mortgages (ARMs). The difference is that a balloon payment may require refinancing or repayment at the end of the period. Some adjustable rate mortgages, however, do not need to be refinanced, and the interest rate is automatically adjusted at the end of the applicable period. Some countries even prohibit balloon payment mortgages for residential housing - the lender has no choice but continue the loan. To the borrower then there is no risk that the lender will refuse to refinance or continue the loan.