Balloon Mortgages Q&A
Question:
Home sales are brisk in my area and I have decided to buy a home even though I will only be in this location for a few years. My lender recommends a balloon mortgage. I have heard bad things about these loans, but the deal seems good. What do you think?
Answer:
A typical 7-year balloon mortgage can seem very good and, if you will absolutely be selling before the 7-year term is up, it might be good for you. But, it is a risk.
First, let’s talk about the benefits of a balloon mortgage.
Balloon mortgages usually have a much lower interest rate than a conventional mortgage. The overall cost of the loan will be lower and the payments will be lower. That makes it attractive. The assumption is that a buyer makes payments for a set period of time, five to seven years, for example. Then at the end of the period, the entire balance is due. The buyer then refinances at the end of the term or sells. In your case, you want to sell so this is probably why the lender recommended this type of loan.
The reason balloons are risky is that people never know what is going to happen in the future.
Buyers may think they can easily refinance at the end of the term. But this might not be possible. The buyer may lose a job or become an unqualified buyer because of bad credit. Then it might be impossible to refinance.
In the current market, property values are going up. But, if property values go down, you could be stuck with a home that is not worth the balloon payment. No lender will finance under those conditions. In your case, you might not be able to sell at the necessary price.
Finally, interest rates could be much higher in seven years. For someone who wants to refinance, this could make payments dramatically higher.
Some balloon mortgages have a reset option that will automatically recalculate the mortgage at the current interest rates. This might be good protection for most people.
If you know you will sell, a balloon mortgage might be acceptable.
