Balloon mortgage – definition and meaning

A balloon mortgage, also known as a balloon payment mortgage or a balloon loan, is a type of home loan where borrowers have to make regular payments for a specific period, and then settle the remaining balance relatively quickly with either one huge payment or a few large ones.

In other words, the mortgage does not fully amortize over the term of the note, which leaves a balance due at maturity.

In some cases, the balloon mortgage may consist of 10-years during which the borrower pays on just the interest, and then a final ‘balloon’ payment is made in one huge installment at the end.

As with many conventional long-term mortgages, with a balloon mortgage in most cases the borrower has the option of early repayment.

Balloon mortgage
With a balloon mortgage, a giant payment is made at the end of the term.

The total debt repayment on a balloon mortgage is typically lower than that of conventional fixed-rate ones.

Balloon mortgages are more commonly taken by commercial entities than private individuals. The loan may have a fixed or floating interest rate.

Why would a borrower take a balloon mortgage instead of a conventional 30-year one? Perhaps the borrower does not expect to own the property in 10 years time, he or she may expect to have a lot of money in a few years’ time. Also, balloon mortgage interest rates tend to be lower than on other types of mortgages.

The Consumer Financial Protection Bureau, part of the US government, defines a balloon loan as follows:

“A balloon loan is a mortgage that requires a larger-than-usual one-time payment at the end of the term. This can mean your payments are lower in the years before the balloon payment comes due. Generally, a balloon payment is more than two times the loan’s average monthly payment, and often it can be tens of thousands of dollars.”

If borrower cannot pay the ‘balloon’?

Sometimes the borrower may not have the funds to meet the balloon payment at the end of the loan term. Many contracts include a ‘two-step’ mortgage plan, also known as a ‘reset option’ – the loan ‘resets’ using current market rates and using a fully amortizing payment schedule.

To use the reset option, which may not necessarily be automatic, the borrower has to continue being the property’s owner/occupant, have no 30-day late payments over the past 12 months, and no other liens against the property.

For balloon mortgages that don’t have the reset option, it is expected that the borrower has either sold the property or refinanced the loan by maturity, so there is a refinancing risk.

In some parts of the world, balloon mortgages for residential housing are not allowed – the lender must continue the loan, i.e. a reset option is obligatory. This means that for the borrower there is no risk that the lender might refuse to refinance or continue the loan.

Consider carefully before choosing

The Consumer Financial Protection Bureau warns Americans not to assume that they will be able to sell their property or refinance their loan before they have to make a balloon payment.

If the value of the property declines, or the borrower’s financial circumstances deteriorates, he or she might not be able to sell or refinance in time. “If you’re not sure how you would manage to pay off the balloon payment when it comes due—for instance, out of your savings – consider another type of loan,” the Bureau adds.

A bullet loan is one where the principal is not paid until the end of the term. This type of loan includes balloon mortgages and loans for other purposes.

Video – Balloon payment mortgage