Balloon mortgages have floated in and out of the U.S. mortgage industry. It’s easy to see why: they offer smaller monthly payments until a big one comes at the end of the loan. The Consumer Financial Protection Bureau has released guidelines that exclude a balloon payment feature in qualified mortgages, subject to certain exceptions.
Balloon Mortgages: How They Work
Balloon mortgages have features similar to an adjustable-rate mortgage and a fixed-rate mortgage. Let’s look at their characteristics:
Rate. Balloon mortgages often have rates lower than other mortgages. The rate is fixed throughout the life of the loan.
Payment. Monthly payments on balloon loans are slightly lower and fixed. One can make smaller payments or interest-only payments until such time as a one-time big-time payment is required to pay off the loan.
Term. Balloon mortgages have shorter repayment schedules, usually spanning five to seven years.
Due date. This is when the larger monthly payment becomes due. The borrower has the option to refinance, sell off the property or pay off the loan in full in cash.
Borrower. Given its nature, a balloon mortgage is for borrowers who don’t have much cash in the short term but can afford to make a large final repayment as the loan term ends.
Balloon Mortgages: How to Deal With the Due Date
If you are dreading your mortgage’s due date, here are some actions you can take:
Option 1: You can take out another loan and use the loan proceeds to pay off the old balloon mortgage. This allows you to repay the old loan in full and fly into the safety of a fixed-rate mortgage.
Refinance makes the most sense when rates are lower or at least on the same level when you first took out the loan. To refinance, you must meet the lenders’ qualifications — credit, income, assets, and equity. Also when you switch from a 5-year or 7-year balloon mortgage to a 15-year or 30-year fixed mortgage, you are effectively extending the time you need to repay the mortgage loan.
Option 2: You can sell the home and use the proceeds from the sale to pay off the balloon mortgage in full.
A sale makes the most sense if the value of the home exceeds the debt owed on the loan. Otherwise, you could be pushed to do a short sale, which is a negative mark on your credit report and lowers your credit score in the process.
Option 3: Face the due date and fully repay the balloon loan.
This won’t be a problem if you are liquid enough to make the ballooned payment as it becomes due. But for those who can’t produce that twice as much money for the final repayment, they’d have to consider the options above.
To answer the question, it’s hard to tell what future awaits balloon mortgages. One thing is certain: In taking out a balloon mortgage, be prepared to deal with contingencies that come with owning one.