Balloon Mortgage: What It Is and How to Get One

A balloon mortgage is a medium-term real estate loan that allows borrowers to make low or no monthly payments. The remaining mortgage balance is due as a lump-sum balloon payment at the end of the loan's term.

Unlike typical mortgages designed with payments that extinguish the debt over time, balloon mortgages have a non-standard amortization, which may be beneficial or detrimental, depending on your borrowing needs.

We'll review what sets balloon mortgages apart from other real estate loans, who might benefit from this type of financing, and a few other essentials you should know before applying with a lender.

Key Takeaways

• Balloon mortgages are a medium-term loan typically ranging from five to ten years.

• Unlike fully amortized loans, balloon mortgages do not satisfy your debt organically and require a final balloon payment to cover the remaining balance.

• You can find balloon mortgages requiring principal and interest payments, interest-only payments, or no monthly payments.

• Balloon mortgages are risky since failing to make your final balloon payment would put your loan into default, potentially allowing the lender to foreclose on your home.

What Is a Balloon Mortgage?

A balloon mortgage is a home loan where you make smaller payments—or sometimes no payments—during the initial term, but a large, one-time payment is due at the end of the loan. This final payment, called a "balloon payment," is significantly larger than the earlier payments and is required to fully pay off the remaining balance.

The loan term is usually short, around five to ten years, but the payments made during that time often don’t cover the full loan amount. During this period, borrowers may be expected to make principal and interest, interest-only, or no monthly payments.

To handle the balloon payment, borrowers typically refinance the loan, sell the property, or pay the lump sum from savings. Balloon mortgages are more common among smaller private lenders and are popular with certain borrowers, like real estate investors or those planning to own the home for a short time. For most people, however, a conventional or government-backed loan may be a better choice.

Since balloon mortgages are non-conforming, there's no single set of rules regarding eligibility. Each lender is free to set their own qualification requirements.

Types of Balloon Mortgages

Lenders can structure balloon mortgages in various ways, and many companies are willing to work with borrowers to develop a repayment structure that best suits their home loan needs. Generally speaking, however, these loans can be divided into three categories:

• Principal and interest

• Interest-only

• No-payment balloon mortgages

Principal and Interest Balloon Mortgage

Similar to a regular loan, principal and interest balloon mortgages have monthly payments that cover their interest costs and a portion of the principal balance. However, loans are usually amortized for a longer period than their term – such as a 30-year amortization on a seven-year balloon mortgage – resulting in lower monthly payments than other similar-length loans.

Principal and interest balloon mortgages satisfy interest debt and reduce a portion of the borrowed balance before the final balloon payment.

Interest-Only Balloon Mortgage

Interest-only balloon mortgages require borrowers to make monthly payments to satisfy the loan's interest costs. They are not, however, required to make any payments toward the principal balance, resulting in even lower monthly costs.

Interest-only balloon mortgages satisfy interest debt but do not reduce the borrowed balance before the final payment.

No-Payment Balloon Mortgage

Borrowers who take out no-payment balloon mortgages are not required to make monthly payments throughout the loan's term. Instead, ongoing interest costs are added to the loan balance.

No-payment balloon mortgages accumulate extra debt through added interest that increases the total balance due at the final payment.

Balloon Mortgage Example

Since the way that balloon mortgages work can vary depending on the type of repayment required, here are three balloon mortgage examples covering no-payment, interest-only, and principal and interest balloon loans.

No-Payment Balloon Mortgage Example

With a no-payment balloon mortgage, your accrued interest charges are added to your total loan balance. For example, if you have a $300,000 five-year mortgage with an interest rate of 6.5%, you won't make any monthly payments, but your final balloon payment will be roughly $411,026, assuming annual compounding interest and no other wrapped-in fees or costs.

Interest-Only Balloon Mortgage Example

Interest-only balloon mortgages do not increase the principal balance since the interest costs are paid monthly.

Using the same example of a $300,000 five-year mortgage with an interest rate of 6.5%, your monthly interest-only payments would be $1,625, satisfying the $19,500 in annual interest and keeping the principal balance at the initial $300,000.

Principal and Interest Balloon Mortgage Example

A principal and interest balloon mortgage example is often the most complex, as different loans can have different principal repayment schedules, each requiring individual calculations.

Using our previous example of a $300,000 five-year mortgage with an interest rate of 6.5% and amortizing it over a 30-year term, a principal and interest balloon mortgage would have a monthly payment of $1,896.

During the first month, $1,625 would go to interest, and $271 would go toward your principal. Over time, a greater portion of your payment is applied to the amount borrowed. At the end of five years, you would have a remaining principal balance of $280,833.

Who Should Consider a Balloon Mortgage?

A balloon mortgage can be a practical source of funding for many borrowers. However, these specialty loans may not be well suited for the average homebuyer. So who, then, should consider a balloon mortgage?

Here are a few of the most common types of balloon loan borrowers:

• Borrowers who have the full funds available but wish to keep them invested elsewhere for now

• Buyers who anticipate receiving cash from an inheritance, bonus, or settlement in the near future

• Real estate investors who plan to renovate and flip a property

• Borrowers who only plan to live in a location for a fixed amount of time, such as for a temporary work relocation or military assignment

• Parents who want to purchase a property as student housing and then sell it once their student graduates

Balloon Mortgage Terms vs. Other Loans

Balloon mortgage terms are generally much shorter than other types of loans. While it may be possible to find a lender willing to customize a balloon mortgage to your individual needs, the majority offer terms of ten years or fewer. Loans between five and seven years are the most common option.

In addition to the shorter term, you are also responsible for making a final large balloon payment to satisfy your debt at the end of the mortgage. By comparison, other fully amortized loans satisfy your debt organically as they mature.

Conventional mortgages, as well as those backed by the FHA, VA, or USDA, generally offer 15-year to 30-year terms, although shorter or longer lengths may be available in some situations.

Advantages of a Balloon Mortgage

Why do some buyers opt for a balloon mortgage instead of a conventional or government-backed real estate loan? Some of their biggest advantages include:

Lower Monthly Payments

For many homeowners, balloon mortgages offer lower monthly payments than traditional fully amortized loans. That's because many balloon mortgages are interest-only, and some don't have any monthly payments at all.

Even balloon mortgages requiring a principal and interest payment are usually amortized over a much longer term than the loan is for, making their payments comparable to or sometimes still less than other types of financing.

Flexible Qualification Requirements

Conventional loans and government-backed mortgages offered through the FHA, VA, and USDA all have fixed guidelines regarding borrower eligibility and allowable properties. While lenders are free to set their own more restrictive requirements, the minimum program requirements remain in effect regardless of the company you work with.

Balloon mortgages are non-qualified, so each lender sets their own loan requirements. If one balloon mortgage lender denies you, you may still be able to qualify through another company – even if you can’t get approved for a traditional loan.

Faster Loan Processing

Since balloon mortgages do not have to follow the protocols of other types of loans, it's often possible to process your application faster and close on your loan sooner. However, processing and approval times vary by lender, so ask your loan officer or mortgage broker about their expected turnaround.

Disadvantages of a Balloon Mortgage

Balloon mortgages aren’t for everyone. Even the most seasoned real estate investor should take several disadvantages seriously before applying for a loan with a balloon payment.

Risk of Default

Most home loans have steady and stable payments for the entire life of the mortgage, while balloon mortgages require you to come up with a substantial final payment that can sometimes be larger than the amount you initially borrowed.

If you cannot make your final balloon payment, your loan will default, potentially allowing your lender to foreclose on your home.

Slow to Build Equity

Since many balloon mortgages do not require payments toward your principal, the only equity gained may be through appreciation. This is particularly risky with balloon mortgages that require a minimal down payment, as your equity nearing the final payment may not be enough to refinance into a different type of loan.

Potentially Difficult to Refinance

Buyers who plan to refinance at the end of the balloon mortgage term may find that rising interest rates, low home equity, or personal financial changes can throw a wrench into even the most secure plans. If a homeowner finds their balloon mortgage due and can’t refinance, the lender could foreclose on their property.

If you're thinking about a balloon mortgage, consider the possibility that you may not be able to refinance when the balloon payment comes due and work on strategies for minimizing that risk.

Market Swings Can Affect Plans

Balloon mortgages are popular with investors and other homebuyers who only plan to hold onto a property briefly. This most commonly involves covering the final loan payment – often before it's due – by selling the home.

However, unexpected local real estate downturns can make it more difficult for some borrowers to sell as quickly as they need. In the event of stagnant or deflating home values, selling for enough to cover the remaining balance may be challenging.

Balloon Mortgages: Pros and Cons

Still on the fence about a balloon mortgage? Here is an easy-to-digest chart listing balloon mortgages' pros and cons to remember when choosing the right type of loan.

How Can I Pay Off My Balloon Mortgage?

Balloon mortgages get their name from the fact that their final payment is much larger than their other monthly payments. In essence, the payment balloons at loan maturity.

Whether you're simply planning ahead or quickly approaching your final balloon payment, here are a few of the most popular ways to pay off a balloon mortgage.

Pay the Balloon Payment

The most straightforward way to pay off a balloon mortgage is to make the balloon payment. This requires having a substantial amount of cash available, which is best suited for borrowers who had the resources all along, came into a windfall, or steadily set aside extra funds over the life of their loan.

Refinance the Balloon Mortgage

Another popular option is for homeowners to simply refinance their balloon mortgage into a conventional or government-backed loan. This is an ideal option for borrowers who plan to keep their property but may have yet to be able to qualify for a traditional mortgage when they originally took out their balloon loan.

Sell the Property

For investors or borrowers who only planned to keep their purchase for a limited time, selling the property allows them to use the proceeds to pay off their balloon mortgage and potentially profit from appreciation and other increases to home value.

How Do I Calculate the Balloon Payment at the End of My Mortgage?

Calculating the balloon payment at the end of your mortgage can be more straightforward with some types of balloon loans than others:

• Interest-Only Loans: Since you're paying interest charges across your loan term, your balloon payment on an interest-only loan should be your principal balance plus any fees accrued.

• No-Payment Loans: Balloon mortgages with no monthly payments have a final amount due equal to the principal balance, added interest, and any accrued fees.

• Principal and Interest Payment Loans: Principal and interest payment balloon mortgages have a final balance that depends on how your payments are amortized. The longer your loan term and the shorter your amortization schedule, the smaller your final payment should be.

Is a Balloon Mortgage Risky?

Balloon mortgages are better suited for some buyers than others and can carry more risk than regular home loans.

The most substantial risk with a balloon mortgage is default and foreclosure if you are unable to make your final balloon payment. Market shifts, interest rate increases, and personal financial events can all potentially lead to issues once the loan comes due.

Is a Balloon Mortgage My Best Option?

Balloon mortgages can be an excellent option for certain homebuyers. Still, they are not without risks – namely, the substantial lump-sum payment required at the end of their term. However, some borrowers, such as those with considerable assets, who expect a financial windfall, or who only plan to hold onto the property for a short time, may find a balloon mortgage the perfect fit.

To discover what types of home loans you qualify for – and if any better suit your needs than a balloon mortgage – check out the current interest rates and apply with a local lender today.