Understanding balloon mortgages

Balloon mortgages are loans that last for five or seven years, but are based on thirty-year amortization schedules. For some borrowers, this type of loan offers many of the fixed-rate mortgage benefits in a short-term loan package. Balloon loans can be especially beneficial to borrowers who plan to move after a short time. They are generally not as risky as adjustable-rate mortgages, which is usually the other option for homeowners who plan to move after a few years.

Here’s the way it works: borrowers make monthly payments for the first part of the term, which lasts five or seven years. These payments are based on interest rates and payment schedules that are similar to fixed-rate mortgages, which are long-term loans that last for a much longer time (usually fifteen or thirty years). At the end of the five or seven years, borrowers pay the remaining balance of the mortgage in a lump sum (otherwise known as the balloon payment). Typically, this payment is made by resetting or refinancing the mortgage.

Resetting the mortgage is a good option for people who decide not to move. It involves extending the term of the loan to a thirty-year period. Note that during resetting, you will lock into the new market interest rates. It is important to realize that interest rates may have risen during that period, which means that monthly payments might increase. The other option, refinancing, is usually exercised by borrowers who want to move.

The downside, of course, is that since your payments were based on a 30-year amortization schedule, you will likely hold little to no equity on your home at the end of the initial five or seven year term.