What is a Balloon Payment Mortgage? The High-Risk Home Loan Explained
When shopping for a home loan, you will encounter dozens of different products: 15-year fixed, 30-year fixed, Adjustable Rate Mortgages (ARMs), and Interest-Only loans.
But there is one type of mortgage that sounds incredibly appealing on the surface, yet holds the potential to absolutely devastate your financial life if you aren't prepared: The Balloon Mortgage.
Here is everything you need to know about this high-risk financing option.
What is a Balloon Mortgage?
A balloon mortgage is a short-term home loan (usually lasting 5 to 7 years) that behaves like a long-term loan right up until the very end.
During the initial 5 to 7 years, your monthly payments are calculated as if it were a standard 30-year mortgage. This keeps your monthly EMI extremely low. (You can see what a standard 30-year payment looks like using our Home Loan EMI Calculator).
However, because the loan term actually expires in 5 or 7 years, those low monthly payments barely make a dent in the principal balance. When the loan term ends, the entire remaining balance of the house becomes due on a single day. This massive lump sum is the "balloon payment."
An Example of the Math
Let’s say you buy a house and take out a $300,000 balloon mortgage at a 6% interest rate. The loan has a 7-year term, but the payments are amortized over 30 years.
- Your Monthly EMI: $1,798 (Very affordable!)
- What happens in Year 7: After 84 months of paying $1,798, the loan expires.
- The Balloon Payment Due: You will owe the bank a single, lump-sum check for $268,000.
If you do not have $268,000 sitting in your checking account on that day, the bank will foreclose on your house.
Why Do People Take Balloon Mortgages?
If the risk of foreclosure is so high, why do people sign up for these?
- House Flippers: Real estate investors who buy broken-down homes, renovate them, and sell them within 12 to 18 months love balloon mortgages. They get the ultra-low monthly payment while they fix the house, and they pay off the balloon balance using the cash from the sale long before the 7-year deadline.
- Transitional Buyers: If you know for an absolute fact you will be transferred for work in 3 years, you might take a balloon mortgage. You get a cheap payment, and you sell the house before the balloon pops.
- The "Refinance" Hopefuls: Many people take a balloon mortgage with the strict intention of refinancing into a standard 30-year fixed mortgage in Year 5. They use the low initial payments to save money or build their credit score.
The Massive Risks
The third group—the Refinance Hopefuls—are playing a very dangerous game of financial roulette.
What happens if you lose your job in Year 5? Your credit score drops, and no bank will approve your refinance application. What happens if the housing market crashes and your home is worth less than the $268,000 you owe? You are "underwater," and banks won't refinance underwater properties.
If you cannot refinance and you cannot sell the house for enough to cover the balloon, you lose the home.
The Verdict
For the average family looking for a permanent residence, a balloon mortgage is simply too risky. The peace of mind that comes with a standard, fixed-rate 15 or 30-year mortgage is worth paying a slightly higher monthly EMI. Leave the balloons to the professional house flippers.