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Balloons are fun, right? Balloon mortgage loans may or may not be quite as enjoyable. Depending on your circumstances, a balloon mortgage may be the answer to your prayers or your worst nightmare. Basically, a balloon mortgage will have a monthly payment based on a long term amortization (payoff) but for which the balance will be due in a much shorter period of time than that for which the payment is calculated. Here is a brief example of the good news/bad news potential of this type of loan.
You have the opportunity to buy a great property that is under priced but beyond your normal affordability because of your debt-to-income position. If you can find a way to buy it and keep it for a few years, you might be able to sell it for a great profit. You select a Balloon Mortgage loan because you can afford it for the short term. Why? It is written with a 40 year amortization (pay off schedule) but the balance is due in ten years. The 40 year pay back schedule results in a much lower than normal payment, which you can afford, and in a few years, you can sell the property for a good profit. In this example, a Balloon Mortgage loan may be perfect for you.
A second situation that may make a Balloon Mortgage loan a good choice is when you have the opportunity to purchase an owner-occupied home for a wonderful price but the cost of the property is still beyond an amount that your income supports. Using the monthly payment reductions of a Balloon Mortgage, you qualify to purchase the property. Your loan balance is due and payable in a shorter term than the amortization (pay back) period calculated but you believe you can re-structure your loan before the shortened due date.
The potential problems: You haven't refinanced or sold the collateral (the real estate) and your balloon date is coming due shortly. Mortgage interest rates have been – and continue – to increase and you still owe a large balance. Unless you win the lottery before the balance due date, you must refinance your loan at interest rates that you do not like. Or worse, you cannot afford to refinance because the resulting monthly payment at current interest rates is more than your income can support. You are facing potential financial disaster.
As you can see, Balloon Mortgages can be a very useful, helpful financing source or a possible recipe for financial Armageddon. Like many other financial products, Balloon Mortgage loans can be very positive tools or quite dangerous choices. As always, give all your choices serious consideration and analysis. This philosophy will give you the best chance to make the right financing decisions.