Balloon loans are a great choice for home buyers who wish to pay a fixed low interest rate on their loans. With a shorter term than the typical mortgage loan, balloon loans must be repaid in five to seven years. Payments for a balloon loan are calculated in the same way that payments for normal loans are calculated but, because the term is only 5 to 7 years, the borrower will have to make a large payment at the end of the term.
This characteristic makes balloon loans an ideal choice for borrowers who are expecting to come in possession of a large amount of money or a higher salary in the near future. This type of mortgage loan also benefits people who move a lot, and do not intend to keep a home for longer than a few years.
There are basically two types of balloon mortgage loans: regular mortgage loans that have a balloon clause, and actual balloon loans, where the borrower has to make a large payment at the end of the term, after making normal monthly payments for five to seven years.
Advantages of Balloon Loans
Balloon loans are not for everyone, but there are several key advantages to using this type of loan. Here are the most important ones:
- Low down payment. One of the main advantages that a balloon loan has is the low down payment requirement, which allows a larger number of borrowers to qualify. If you are not doing very well financially, but are expecting to receive a large sum of money in the near future, then balloon loans might be a great choice.
- Low interest rate. Considered by most lenders to be a low risk loan, a balloon loan has the same or an even smaller interest rate than a conventional loan.
- The large payment can be refinanced. If a borrower is unable to pay the large amount due at the end of the balloon loan term, he can refinance, but he will most likely have to pay higher interest rates than usual.
Disadvantages of Balloon Loans
Every type of loan also has a few disadvantages. When shopping around for loans you must take both advantages and disadvantages into consideration. Balloon loans have the following disadvantages:
- Large payment at the end of the term. When the loan matures, normally in 5 to 7 years, the borrower is required to pay the remaining sum. Because the term is so short, the remaining amount will be quite large, and can create difficulties for borrowers who didn’t plan accordingly. Borrowers must have access to a large sum of money in order to make this last payment, if they decide to go with a balloon payment.
- Bigger risk of losing your home. You will risk losing your home with any type of loan, due to poor planning or unforeseen events, but the risk is much greater with a balloon loan. Not only will you need a large sum of money to make the last payment, but being unable to qualify for a refinance will increase your risk of foreclosure.
Balloon loans are obviously risky and not recommended to most home buyers, but they can be the correct choice for those who don’t plan on keeping a home for long, and for those who are expecting to receive a large amount of money in the next few years, or receive a large pay increase.