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Have a question? Ask our Home Buying expert.

Have questions? Email Send your question to mlerner@smartasset.com

Ask Our Home Buying Expert

Have a question? Ask our Home Buying expert.

Have questions? Email Send your question to mlerner@smartasset.com

Pros and Cons of a Balloon Mortgage

Your balloon mortgage loan might have seemed like a good idea when you first applied for it. Maybe it meant that your monthly mortgage payments have been lower so they fit into your budget. But now your mortgage balloon payment is due and you can’t afford to make it. Before you start panicking, it’s important to keep in mind that you do have some options.

Check out our mortgage calculator.

Depending on the value of your home, you might have to rely on the kindness of your mortgage lender. And in a worst-case scenario? You might end up losing your home to foreclosure.

What Is a Balloon Mortgage Payment?

A balloon mortgage comes with an unusual twist. You make normal monthly payments for a set period of time (usually five to seven years) and then you have to make one large payment to pay off the remaining balance of the loan. That large payment is the “balloon” part of a balloon loan. And depending on the size of your mortgage, that payment can be tens of thousands of dollars.

Say you took out a balloon loan of $100,000 with a term of five years and an interest rate of 5% amortized over 30 years. Because you are not paying off the loan for that full 30 years — indeed, you’re only making payments for five years — you’d owe $91,829 after 60 months worth of payments. You’d have to pay that off in a lump-sum payment.

The Advantages of a Balloon Loan

Pros and Cons of a Balloon Mortgage

Balloon mortgages should come with a lower interest rate than either fixed-rate or adjustable-rate mortgages, making them a cheaper loan for the right consumers.

Those consumers who plan to live in a home for only a short period of time, might do well to take out a balloon mortgage. Say they plan to move in three years. They can take out a five-year balloon mortgage at a lower interest rate and then sell their home long before that massive balloon payment becomes due.

This can also be an option for someone who gets large bonuses but a more moderate salary. A balloon loan would allow the monthly mortgage payments to fit into their budget and then they could use the larger yearly lump sums toward the balloon payment.

The Problems With This Kind of Loan

There is a big risk associated with a balloon mortgage, though. Most homeowners who don’t plan to sell their homes before the balloon payment is due expect to refinance their balloon loan to a standard fixed-rate or adjustable-rate mortgage before facing that big payment.

And that is often the best move if you can’t afford your balloon payment: Refinance your loan before you have to pay up.

Tackle These Home Improvement Projects Before You Refinance

But what if your home has lost value since you bought it? What if you are underwater on your home loan, meaning that you owe more money on your mortgage than what your residence is worth? This isn’t that rare today. Studies show that 5.1 million homes with a mortgage had negative equity in the third quarter of 2014, meaning that the owners of these residences owed their lenders more than what their homes were valued at.

It’s not easy to refinance a mortgage loan with negative equity. Most lenders require that you have at least 20% equity in your home before they’ll approve your request for a refinance. You might be able to refinance through HARP, but you have to meet certain requirements to refinance through this program.

Try out our free refinance calculator

What You Can Do If You Can’t Refinance

Pros and Cons of a Balloon Mortgage

If you can’t refinance, can’t or won’t sell your home and can’t afford your balloon payment, what are your options? Not many.

Your best move is probably to call your existing lender as soon as you realize that you can’t cover your balloon payment. Your lender might offer to extend your existing loan for another five years before another balloon payment looms. That would give you more time to pay off some of what you owe and hopefully build positive equity in your home. You might then be able to refinance your loan.

Your lender might also offer to refinance your loan on its own. Your lender might see this as a better option than having to take your home through the foreclosure process.

But if your lender isn’t willing to negotiate? Then you might face the unhappy prospect of losing your home to foreclosure.

Photo credit: ©iStock.com/nandyphotos, ©iStock.com/eli_asenova, ©iStock.com/XiXinXing

Dan Rafter Dan Rafter has been writing about personal finance for more than 15 years. He is an expert in mortgages, refinances and credit issues. Dan's written for the Washington Post, Chicago Tribune, Phoenix Magazine, Consumers Digest, Business 2.0 Magazine, BusinessWeek online and dozens of trade magazines.
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