Balloon Loans

Balloon loans are short term mortgages that have some features of a fixed rate mortgage. The loans provide a level payment feature during the term of the loan, but as opposed to the 30 year fixed rate mortgage, balloon loans do not fully amortize over the original term.

Balloon loans can have many types of maturities, but most balloons that are first mortgages have a term of 5 to 7 years. At the end of the loan term there is still a remaining principal loan balance. Their initial monthly payments are usually based on a 30-year amortization schedule, and you have a choice at the end of the 5- or 7-year term to either pay off the remaining balance, refinance or reset the mortgage. So you have the advantage of a low monthly payment, like someone with a 30-year loan, but you must pay off the loan at the end of the specified term.

Many balloon mortgages have a "reset" option. That means you can reset the interest rate of your mortgage to the current market rate for the remainder of the amortization period. This option is typically only available if:

• You're still the owner and occupant of the home.
• You've paid your mortgage on time for at least a year prior to the balloon note maturity date.
• You have no other liens against the property.
• If you do not qualify for a reset, you may qualify to refinance your balloon/reset mortgage.

There are additional considerations to be aware of with balloon/reset mortgages:

If you plan to sell your home before the balloon maturity date of the balloon/reset mortgage, this type of mortgage, like an ARM, may be a good option. Balloon/reset mortgages usually come with a slightly lower initial rate than most other fixed-rate mortgage types. You may qualify for a larger loan amount with a balloon/reset mortgage than you would with a fixed-rate mortgage.

Unlike ARMs, whose interest rates may reset or adjust a number of times over the loan's life, a balloon mortgage comes with only adjustment. However, if interest rates rise sharply during the term of the balloon loan, you could face a large increase in your monthly payments when you reset or refinance your mortgage. If your financial condition has changed at the end of the balloon term because of a decline in income, family medical problem, etc., you may have difficulty refinancing into an acceptable new mortgage. What the numbers mean. There are 2 types of balloon/reset mortgages: 7/23 and 5/25. The two numbers together are the total number of years (30) the payments will be based on. The 1st number (7 or 5) is the number of years before the balloon maturity date. The 2nd number (23 or 25) is the balance of the term.

Sometimes balloon loans have features that allow borrowers to convert the mortgage at the end of the initial term to a fixed rate mortgage for the remainder of the 30 years. For example, a 5/25 convertible means that at the end of a 5 year balloon loan term, a mortgage will convert to a 25 year fully amortizing loan based on the current interest rates; at the end of 25 years the loan will be paid in full. Other times, balloon loans may convert to an adjustable rate mortgage (ARM) at the end of the balloon period.

Balloon mortgages may be a good option if you know that you will only need the mortgage for a given time or you plan to refinance before the initial term is up. Because balloon loans are considered short term mortgages, the interest rates are generally lower than 30 year fixed mortgages.