What is Balloon Mortgage, different types of balloon mortgages and why and if you should choose a balloon home loan
Simply put, balloon mortgage mortgages are home loans that require the entire amount to be paid off after a certain period of time by making a large payment equivalent to the balance remaining on the loan. Usually these kind of mortgages amortize during the initial few years but then required to be completely paid off much sooner than the entire term of the mortgage is over. As we have discussed earlier the meaning of amortization is that each monthly payment is equivalent to the amount that will pay off your mortgage completely if you continue to make that payment for the entire term of the mortgage.
First mortgages are usually completely amortized. After you make the last payment according to your amortization schedule your mortgage should be completely paid off. However, most of the second mortgages are balloon mortgage is where they become due long before there are close to being fully repaid. Although second mortgages can also be fully amortized mortgages, they are often balloon home loans.
The final installment that pays off for second mortgage completely with its entire remaining principal balance is called the balloon payment. Many lenders also refer to balloon home loans as bullet loans because they have the ability of blasting mortgage borrower of their feet and into financial and fiscal doldrums.
Balloon mortgages have their own advantages where they can augment your cash for a down payment, reduce your interest rate or help you put equity out of your present home to buy your next home. They can be extremely useful resources when used properly but extremely dangerous if used without understanding their functions. In this section we have going to discuss some common balloon mortgage loans.
A balloon mortgage is a mortgage that is payable in full after a certain period of time.
A balloon mortgage in today’s date is usually calculated on our 30 year, amortization schedule. Even though the repayment of the loan may be due in the next 5 to 10 years, there is some sort of a principal reduction because of this calculation. Assuming a rate of 6.5% on a $100,000 loan the balance remaining to be paid up at the end of a 5 year Balloon Mortgage would be $93,611.
Comparing a Balloon Mortgage to an ARM
The features available on an ARM can also be compared to balloon mortgage. What both these kind of mortgages have in common is that they offer low rate of interest during the initial years and a higher payment requirement after this initial duration is over. There are however differences between a balloon mortgage and an ARM. The one notable difference is that balloon mortgage will require the prepayment of the complete loan after the initial duration is over. Whereas an ARM will only change its interest rate according to the prevailing index rates that it is tied to. A balloon mortgage requires the prepayment of the entire loan much before the terms of the mortgage paid as an ARM requires the repayment of the mortgage over the entire term of the mortgage. The following are some of the features that distinguish a balloon mortgage from an ARM.
Features of the balloon mortgage that make it advantageous as compared to an ARM
Balloon mortgages are simple to understand and easier to shop for.
The interest rate on a five years or seven year balloon mortgages typically lower than that on our 5/1 or 7/1 ARM.
Features favoring the ARM over a balloon mortgage
A balloon mortgage requires the complete repayment of the mortgage after the initial duration. It poses a higher risk of high interest rate if the prevailing rate for a refinance is substantially higher. An ARM is limited by rate caps.
Borrowers with a five or seven year balloon mortgage will incur refinancing costs whereas those holding and ARM 5/1 or 7/1 will not need to do so unless they choose to refinance.
It may be a problem trying to get refinance for balloon mortgage specially if the borrower has missed a payment in the previous year. The lender is under no obligation to refinance the mortgage and he might refuse. This will put a great burden on the borrower because he will need to repay the entire mortgage amount or become delinquent on the mortgage which might lead to foreclosure. This is not a problem with an ARM because it does not have to be refinanced.
A balloon mortgage contract allows lenders to decline to refinance if the current market rates are more than 5% higher than the rate on the balloon.