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With a traditional real estate loan, borrowers, whether they are homeowners or real estate investors, pay a fixed monthly payment for the loan term, commonly 15, 20, or 30 years.
This payment consists of repayment of the principal and interest on the loan balance. The longer it takes for you to repay the loan, the more you pay in interest.
The amount of interest paid can be nearly as much as the loan’s face value. Therefore, the interest owed absorbs the majority of your monthly payment for many years into the loan. As the principle slowly reduces, so does the interest, and more of your payment gets applied to the principal.
Now, suppose you want to build a commercial property that won’t have tenants or positive cash flow for a while.
Or you’re an investor and found a deal on a property you want to flip.
Maybe you just started a promising career, and you’re looking to buy a first home.
In each of these scenarios, committing to a lengthy mortgage with a large down payment and a high monthly payment may not make the most sense.
This is where a balloon mortgage comes into play.
In this article, we’ll break down the advantages and disadvantages of a balloon mortgage to help decide if it’s right for your financial situation.
What is a Balloon Mortgage, and How Does it Work?
A balloon mortgage is a real estate loan with a short term of five to ten years, and the payments are the result of a 30-year amortization.
Unlike a conventional mortgage, the payments only include interest charges, which also keep the payment low.
A payment towards the end of the loan, called a balloon payment, covers the entire loan balance and is usually quite large — usually 60%-70% of the original loan balance.
Advantages of a Balloon Mortgage
A balloon mortgage has many benefits. They include:
Low Monthly Payments
A balloon mortgage has low monthly payments that only include repayment of interest.
The low payment allows balloon mortgage borrowers to save hundreds of dollars each month compared to a traditional 15 or 30-year mortgage.
Plus, you’ll be able to avoid the large payments for several years — a tremendous advantage.
Address Your Finances
By paying a low amount each month, you can instead put other money towards addressing other financial needs.
For example, you can:
Afford a Property Quickly
If you don’t have the funds for a downpayment or a high monthly payment, a balloon mortgage will help you obtain a property faster than you otherwise could, whether you’re buying a home or real estate investing.
Disadvantages of a Balloon Mortgage
A balloon mortgage comes with downsides as well.
This includes:
Large Payment Due at the End of Loan Period
A substantial payment is due at the end of the loan period.
Most people intend to refinance before it is due ... but what if the market is down?
The property’s value could be less than the balloon mortgage balance, making it nearly impossible to get a loan.
Alternative Mortgage Options Have Better Rates
Other mortgages, such as an FHA or VA loan, typically have better rates than a balloon mortgage.
Plus, these loans don’t fully amortize, so you won’t have to pay a lump sum payment towards the end of the loan.
Increase in Interest Rates
Interest rates can be higher by the end of the balloon mortgage term.
This can make the refinance payment higher than it would have been if you had used a conventional loan.
Balloon Mortgage Calculator
Now that you know the advantages and disadvantages of a balloon mortgage, you may have a more clear idea if it’s right for you.
But before choosing a balloon mortgage, we recommend calculating your payments to see if it’s right for you.
You can do that with these options:
The Bottom Line: Balloon Mortgage
Balloon mortgages aren’t for everyone — but they can be advantageous in the right situation.
The idea of a low monthly payment is enticing for home buyers and real estate investors alike.
But before you choose a balloon mortgage, keep in mind these advantages and disadvantages, especially the fact that there will be a lump sum payment due towards the end of the loan, and you don’t want to be scrambling for ways to pay for it.
