Balloon Payments

Some borrowers, looking for lower monthly payments, will sign on to a loan to refinance a mortgage that has a balloon payment due at the end of the loan. What exactly is a balloon payment and is a loan with a balloon payment right for me?

A balloon payment loan is a loan that has a monthly payment that is lower than the payment for a similar-sized loan that is fully-amortized. The lower monthly payments may be attractive to borrowers on a tight budget or the lower payments may help marginal borrowers qualify for a loan in the first place, or it may help them qualify for a larger loan for which they would otherwise qualify.

However, the lower monthly payments come with a price. The reason that the monthly payments are lower is because you are not making a normal payment toward paying down your principal each month. Due to the fact that you are only paying a small part of the principal each month you are, in effect, falling further and further behind in your payments with each passing month. At some point, the shortfall in your payments must be repaid.

In other words, at some point the piper must be paid and the interest that you have been putting off paying must be paid in full. With a balloon mortgage the unpaid principal must be paid in full in one lump sum.

If you have planned all along to sell the property just before the balloon payment is due, then a balloon-payment mortgage loan may be perfect for you. The risk, of course, is that the market will allow the sale of your home in the allotted amount of time you have left before your loan payment time arrives.

The lump-sum can also be paid out of personal funds. It also may be possible to refinance the loan again at the then-current interest rates.