Balloon mortgage or loan is a short-term mortgage that is similar to that of a fixed rate mortgage. The loan grants a payment level feature during the loan term, but contrary to the 30-year fixed rate, it does not fully amortize over the original loan term. There are several kinds of maturities for this kind of mortgage but mostly they are first mortgages with a term of five to seven years only.
At the end of the term, there is still the principal loan balance to be paid and the mortgage lender will require this to be paid in full through refinancing. The final payment made is called a balloon payment due to its large amount. Balloon mortgages are more common in a commercial real estate than in a residential one.
Some people choose a balloon mortgage since it allows one to have a lower monthly payment and lower rate of interest for the first five or seven years of owning the home. This may appear perfect for those who think that their income will increase and interest rates will go down.
Others opt for this mortgage because they do not believe that they will stay in the house for the full five or seven years until their mortgage is due. Thus, they want to enjoy the low fixed interest rates for the duration of their stay in the property.
Nevertheless, this type of mortgage can have its risks. The main risk with t his kind of mortgage is you will be unable to refinance into an affordable loan when your balloon payment is due. If the value of your property falls or your income goes down before your mortgage is due, you may not get qualified for a new mortgage to pay off your principal balance. In this event, your house may be subjected to foreclosure.
There is also the possibility that the rates of interest will go up and therefore you would have to refinance into a more expensive mortgage as soon as your balloon becomes due.
It is difficult to predict the interest rates in the market in the future. They could decrease but they could also increase. When choosing a balloon mortgage, you have to be aware about the future rates of interest since you will be subjected to them when your balloon mortgage matures.
While the possibility of this situation happening might be low, it is not impossible. When you have this type of mortgage, you should be ready and prepared to find alternative plans in the event that your primary or secondary plan fails. Although balloon mortgage makes it easy to afford the monthly payments, there could be difficulty when it matures.
At the time of maturity, you have several choices such as selling your home, convert the balloon mortgage to a traditional loan or refinance it. Nevertheless, converting and refinancing it needs a credit approval.
It is of vital importance that you understand fully what a balloon mortgage is before you opt for this kind of home financing.
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