A balloon loan is a mortgage with a fixed interest rate for a set period of years. Unlike traditional fixed rate home loans, the interest rates on balloon loans are nearly as low as those found on adjustable rate mortgages. The problem with balloon loans, however, is the term. At the end of the term, you must repay the balloon loan in full. Yes, in full!
Balloon mortgages are considered a little higher risk because at the end of the life of the loan, there can be a large payment as the loan is due in full. The life of the loan is negotiable; however 3, 5, and 7 year balloons are common. The home owner pays at a fixed interest rate for the life of the loan, and then at the end of the term, all the remainder of the loan must be paid in full. The home owner must be prepared for this final, possibly very large payment.
This mortgage is very risky because the total due remaining on the loan is due at the end. Planning on staying in a home past the length of the loan can be a gamble. But if some reason you plan on moving before the term is due, the lower interest rate might make this loan a good deal. However, if you don’t, you could face much higher mortgage rates or as we have seen in recent years, declining home values which would require you to come up with cash to pay the difference between what you owe and how much a lender is willing to finance.