Our goal is to give you the tools and confidence you need to improve your finances. Although we receive compensation from our partner lenders, whom we will always identify, all opinions are our own. Credible Operations, Inc. NMLS # 1681276, is referred to here as "Credible."
A balloon mortgage might be appealing when it offers a lower mortgage rate — and therefore a lower monthly payment — than a conventional fixed-rate loan.
Since many homeowners don’t plan to stay in their homes long term, a loan with short-term savings can be enticing. Still, accepting responsibility for a large balloon payment is a major risk.
Here’s what you need to know about balloon mortgages:
- What is a balloon mortgage?
- How balloon mortgages compare to other home loans
- Should you get a balloon mortgage?
- Alternatives to a balloon mortgage
What is a balloon mortgage?
A balloon mortgage is a home loan that requires fixed monthly payments for the first several years. After that, you’ll have to pay the remaining principal balance at once.
Here’s how that happens. With a balloon mortgage, the term is far shorter than the amortization period:
- Term: The number of years the borrower has to repay the loan.
- Amortization period: The number of years over which the loan’s payment is calculated.
For example, the popular 30-year fixed-rate mortgage has a 30-year term and a 30-year amortization period. You make the same payment every month for 30 years (360 months), and then you’ve completely paid off your loan.
A balloon mortgage, by comparison, might have a five-year term and a 30-year amortization. You’ll make the same payment every month for five years (60 months) that you would have made on the loan with the 30-year term. But after that, you’ll owe all of the remaining principal.
What is a balloon payment?
A balloon payment is a large sum of mortgage principal due at the end of a balloon mortgage’s term.
Essentially, you’re not paying enough principal to pay off the loan in the years leading up to the end of the term. As a result, the balloon payment you’ll make at the end of the loan could be tens or hundreds of thousands of dollars.
Once the term ends, you’ll need to make that lump-sum payment. Here’s how you might choose to pay for it:
- Save up for the payment during the loan term, then pay it off
- Sell the home to pay it off
- Refinance into a traditional mortgage
- Extend the loan at current rates, if your lender allows it
How balloon mortgages compare to other home loans
Here’s what your payments would look like through the first five years on a $300,000 home loan structured in different ways.
|Interest rate||Monthly payment||Balloon payment|
A 30/5 balloon loan has a 5-year term and a 30-year amortization period. Meanwhile, a 5/1 ARM has the same mortgage rate for the first five years. After that, the rate adjusts once a year for the remainder of the term.
Should you get a balloon mortgage?
If you want the lowest possible monthly payment and plan to sell or refinance before the end of your loan term, you might be tempted by a balloon mortgage.
There is, however, substantial risk involved. Since you’ll be required to make a large payment at the end of the loan, balloon mortgages generally aren’t a good idea for the average homebuyer. Your finances or life plans may not turn out how you predict.
Balloon loans are also not widely available. Fannie Mae does not purchase balloon mortgages and has not for the last decade.
|Lower interest rate||Refinancing might not be possible|
|Smaller monthly payment||Selling might be difficult|
|Alternative to conventional financing||You could lose your home|
- You’ll enjoy a lower interest rate. A lower interest rate can save you money in the short run. Using the numbers from the loan comparison table in the previous section, you’d pay $64,746 over the first five years of the balloon loan, $73,483 over the first five years of the ARM, and $75,889 over the first five years of the 30-year fixed-rate conventional loan.
- The monthly payments are smaller. You can more easily fit a smaller monthly payment into a tight budget. Smaller monthly payments can also help with cash flow in lean months if you’re a business owner whose monthly income fluctuates.
- It’s an alternative to conventional financing. A balloon mortgage may be an option for certain borrowers that don’t qualify for conventional financing. This doesn’t mean a balloon mortgage is a good idea if your finances are unstable. It means it might be an option if your financial profile doesn’t fit the types of borrowers that mainstream mortgages are designed for.
- Refinancing might not be possible. Your income could be lower or your property’s value might have sunk by the time you want to refinance. Interest rates could also be a lot higher than they are now, making your new payment unaffordable. Even if you can refinance, you’ll have to pay closing costs, which might negate your interest rate savings.
- Selling might be difficult. Demand for homes in your area might not be there. A natural disaster, zoning change, or loss of a major employer could make your property less desirable. You might not be able to sell for enough money to pay off your loan, let alone get your equity out.
- You could lose your home. If you can’t make the balloon payment, you can’t refinance, and you can’t sell, there’s a good chance your loan will go into foreclosure. It’s possible the lender could agree to a loan modification, but don’t count on it.
Alternatives to a balloon mortgage
If you’re tempted by a balloon mortgage but put off by the disadvantages, consider these alternatives.
Adjustable-rate mortgage (ARM)
Adjustable-rate mortgages often have lower rates than 30-year fixed-rate mortgages. On top of that, an ARM with a 30-year term can have the lowest monthly payments available outside of a balloon mortgage.
However, the interest rate does reset after the initial fixed period, so these loans still carry some risk. For instance, you might have a low rate for five years, then see annual rate adjustments for the next 25 years.
These annual adjustments are far less risky than owing a balloon payment, though, especially since there are limits on how high an ARM’s rate can adjust.
30-year fixed mortgage
A 30-year fixed-rate mortgage may not be much more expensive than an ARM. For a slightly higher interest rate, you get the security of knowing that your monthly mortgage payment will be exactly the same for the next 30 years.
The stability of the repayment schedule is one reason both 30-year fixed and 15-year fixed mortgages are so popular.
Bank statement mortgage
Contrary to what you might have heard, self-employed borrowers can qualify for conventional loans. But sometimes, taking all those business deductions means your income looks too low to repay a mortgage even though you have plenty of income.
That’s where a bank statement mortgage (also known as no-doc loans) can be helpful, because it places more emphasis on your liquid assets. If you don’t really need the lowest monthly payment possible but are seeking a balloon loan because you don’t know how else to qualify, check into this option.
Shopping around for a mortgage can be stressful. Fortunately, Credible streamlines this process and makes comparing multiple lenders easy. You can see prequalified rates from our partner lenders in the table below in just a few minutes — checking rates is free, and you don’t even have to leave our platform.