What is a balloon mortgage? (2023)

How does a balloon mortgage work?

A balloon mortgage is a type of home loan where you make regular, often lower, monthly payments for a set period — typically five to seven years. After this term ends,  your remaining loan balance is all due at once. This is the “balloon” payment.

If you can't afford to pay off the rest of the loan, you will need to rely on refinancing, selling or modifying your loan. In the worst-case scenario, a lender will foreclose your home if the other options do not work out.

While balloon mortgages can be risky, the initial period of lower payments can be appealing for buyers expecting a significant increase in income or planning to sell or refinance the home before the balloon payment is due.

Balloon mortgage rates

Balloon mortgage rates can vary depending on several factors, including the lender, the borrower's creditworthiness and market conditions. At the time of publishing, Fannie Mae balloon mortgage rates range from 3.25% to 4.26%.

Kristen Conti, broker-owner of Peacock Premier Properties, a real estate company, discusses ARM loans with balloon payoffs with her clients when interest rates are high.

“The way this works is that they can begin their mortgage journey at a lower rate,” she said. “Sometimes this can be as much as 1% to 2% lower than a 30-year fixed.”

» MORE: 13 first-time homebuyer mistakes and how to avoid them

Types of balloon mortgages

While all balloon mortgages are similar, there are some variations. There are three main types of balloon mortgages, and the type you choose affects how large your monthly mortgage payment is.

Interest and principal payments

Your payments may be put toward a combination of interest and principal if you decide to obtain a balloon mortgage. Say you take out a $250,000 loan at 3% for seven years. Your loan may still be amortized like a 30-year loan, but the remaining balance is due at the end of seven years. With a traditional loan, the sum of all of your payments over 30 years would pay off your entire balance.

In this scenario, your monthly payment would be $1,054.01, which includes principal plus interest. On a standard amortization schedule, each payment will have you paying off slightly more principal as you approach the end of the term.

For example, with your first monthly payment, $429.01 is put toward principal, and $625 is put toward interest. The final monthly payment at the end of seven years would include $526.49 for principal and $527.52 for interest. The lump sum due at the end is $211,009.36.

Pros and cons of a balloon mortgage

For some buyers, balloon mortgages can help them secure a home loan at a lower interest rate. But it is a gamble that you’ll be able to repay or refinance the loan by the end of the term.

Here are some other pros and cons of balloon mortgages to consider.

» MORE: First-time homebuyer loans and programs

Paying off a balloon mortgage

Even if you have several years before your balloon payment, it is still essential to have a plan. This is where the risk factor comes in; you don’t know what the future of your finances or the real estate market will look like.

These are your best options for paying off your balloon mortgage:

• Refinance: “If interest rates go down, they may have the option to refinance during the initial time period,” said Conti. “The decision on whether or not to refinance can be made 90 days prior to the maturity of the adjustable period.” Refinancing involves taking out a new loan, either with your original lender or a new one. You will need to meet your lender’s eligibility criteria and pay closing costs.
• Sell your home: Selling is always an option, especially if you don’t love the home or neighborhood. This move is best suited for those who will earn enough proceeds from the sale to cover the balloon payment due.
• Pay it off in full: If you can set aside the right amount of money each month, your balloon mortgage could end with a fully paid-off home.
• Reset option: Check with your lender if your balloon mortgage comes with a reset option. This will allow you to reset the terms and rate of your loan without having to refinance.

Should you get a balloon mortgage?

Balloon mortgages are not right for everyone. Not many lenders even offer them due to their risky nature.

Janis, a reviewer from Ohio, got stuck in a tricky situation due to a balloon mortgage. “I cannot refinance because it is a mobile home. I have asked other lenders to finance and they will not finance what is owed because it does not appraise for the amount we need,” she said.

You should consider balloon mortgages only if you are able to repay the loan in full or can make increased payments on your loan — for example, if you are expecting a large income increase. A balloon mortgage might also be right for you if you don’t plan on staying in your home for long, such as if you are planning to flip the home for profit.

In any case, you should keep your credit score high just in case you need to refinance your balloon mortgage before the lump sum payment is due.

Bottom line

Balloon mortgages are risky. If you are the right type of buyer (someone who wants to avoid high interest rates without putting off buying a home), then this type of mortgage can be your creative solution to do so. You will just need to plan ahead and decide how you will repay the balloon payment without derailing your finances.