By: Edward McCarthy
President: Sell By Owner Listings, Inc.

The Risks of a Balloon Mortgage

If you've ever heard of a balloon mortgage are you've either heard the really good or the really bad about the mortgage. The really good is that, typically, the mortgage has low monthly payments. The really bad is that the full amount of the mortgage is due within five to seven years. This large payment is why the mortgage has its name. With a balloon mortgage both features are true.

With a balloon mortgage, the payments are calculated in a method similar to that of a fixed-rate mortgage. When you make monthly payments, you pay as if you would be paying the mortgage for 30 years. However, you don't have 30 years to repay the mortgage. After a specific period of time, the remainder of the balance must be repaid. If, at the time the loan comes due, you are still in the house, you must refinance a balloon mortgage.

In general, it is easier for homebuyers to qualify for a balloon mortgage than it is for a 30-year fixed-rate mortgage. This is one of the reasons homebuyers choose to obtain a balloon mortgage. If, during the life of the loan, you continue to improve your credit and other qualifying factors, you may be able to refinance the balloon mortgage for a new mortgage, often with better terms.

Balloon mortgages are riskier for homeowners because the life of the loan is shorter than many other loan products. While, it can be fairly easy to make the monthly payments on the mortgage, there could be difficulty once the loan matures.

At the time of the balloon mortgage maturity, you have several options from which you can choose. You can sell your home, covert your balloon mortgage to a traditional mortgage, or refinance the mortgage. Of course converting the mortgage and refinancing it are both subject to credit approval. In addition, you could run into costs associated with the loan transactions. If you are able to convert or refinance the balloon mortgage, you will be forced to sell your home.

It can be difficult to predict what market interest rates are going to do in the future. They could decrease, but they could also increase. When you have a balloon mortgage, you have to be concerned about future interest rates because you will be subject to them when the loan matures. Your loan could come due in a time when there are high interest rates. Since you don't have a rate locked in already, you will be forced to qualify for those higher interest loans.

Not only do you risk high interest rates in the future, you also cannot guarantee that you will be able to refinance in the future. In the worst-case scenario, you could lose your job and the ability to qualify for a new mortgage. Although the probability of this kind of situation occurring might be low, it is not nil. When you have a balloon mortgage, you must be prepared with alternative plans in the unfortunate event that your primary, and even secondary, plan falls through.

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