If you aren’t familiar with mortgage financing options, it is never too late to get started. Understanding the different terms and having the ability to relate them to each other and to your personal situation will help you avoid situations that are not financially viable. One of the terms that you should know is balloon mortgage loans.
This can either help you financially, or cause you problems. Understanding the details of how a balloon mortgage loan works and using it to your advantage will enhance your ability to select the right loan for your purposes. The original description of a “balloon” mortgage loan is a loan on which repayment is made in monthly payments of “interest only” and exclude any principal reduction feature.
Payment was made to principal in one lump sum at the end of a specified term, meaning that if you took out a 10 year balloon mortgage loan for $100,000 at 5 percent, your monthly interest payments would probably be calculated at $417 per month (rounded to the nearest dollar), and you would have to come up with $100,000 in one lump sum on the due date in 10 years. Folks who opt for balloon mortgage loans do so in order to take advantage of the lower monthly payments.
If you are exposed to balloon loans over a period of time, you’ll find that “Some balloon loans, such as a five-year balloon mortgages, have a reset option at the end of the five-year term that allows for a resetting of the interest rate (based on current interest rates) and a recalculation of the amortization schedule based on a remaining term. If a balloon loan does not have a reset option, or frequently even when it does, it is expected that the borrower will sell the property or refinance the loan before the end of the original loan term.” This according to Investopedia on the Web.
There have been a number of creative changes to the balloon mortgage loan over the years, and during the subprime mortgage era some lenders offered balloon mortgage loans with a feature which consolidated a specific percentage of the loan each month. At the end of your agreed-upon term, you were required to pay the additional percentage that is left. In many cases, this equalled about fifty percent of the loan that you had taken out.
You can work with balloon mortgage loans to your advantage if you have the right finances in place. For example, if you know that you will have a large sum of money at a given time or date in the future, borrowing money under the terms of a balloon mortgage loan would make sense as long as you arrange the end of your loan term to coincide with the date you will receive the large sum of money. It is circumstances like these when having a balloon mortgage loan can help you to save now and build your credibility with financial investments later.
If you aren’t certain of your financial picture and what it will look like in ten years, then a balloon mortgage loan will most likely not be right you. Because since you will be expecting to pay a large (lump sum) amount at the end, it can lead into debt – or foreclosure if you don’t have the money – and therefore won’t help you to make an investment on another house in the future.
On the other hand, if your income is a specific amount now but you know that it will increase later, then you can use a balloon mortgage loan in order to stabilize your financial conditions by refinancing into a higher payment amortized loan.
By using an exotic balloon mortgage loan (if you can still find a lender that offers such a loan), you will be put into a situation where your mortgage will blow up to twice as much at the end of the term. This can be an advantage or a disadvantage, depending on your situation. By knowing exactly how to tie the end of your balloon mortgage loan into your expectant good fortune, you will be a good position to find the best financial options for your situation.