Balloon Payment: Pros & Cons of a Balloon Payment Mortgage

Key Takeaways


When you’re shopping for a mortgage, you might consider taking out a mortgage with a balloon payment. A balloon payment is when you pay the remaining balance of your mortgage in a large lump sum.

Let’s discover how balloon payments work, and weigh the pros and cons.

What is a Balloon Payment?

A balloon payment is a large payment that’s due at the end of a balloon loan. Balloon payments may be included on residential and commercial mortgages or on any amortized loan (any loan in which you make scheduled, recurring payments).

Balloon payments are usually set up on short-term loans. You’ll make smaller, recurring payments until the balloon payment is due. On the balloon payment, you’ll pay the remaining balance of the loan.
As the term “balloon” suggests, the balloon payment is disproportionally large compared to the other payments on the loan. Most balloon payments are at least twice the amount of all the loan’s previous payments.

For example, let’s say you take out a 5-year mortgage of $300,000 and your monthly payment is $1,200. You’d pay $70,800 over 59 months. In the final month of the loan term (the 60th month), you’d pay a balloon payment of $229,200.

Balloon payments are most commonly used in commercial loans. Most homeowners cannot afford a balloon payment. However, they can be an effective strategy for real estate investors.

What is a Balloon Mortgage?

A balloon mortgage is a mortgage loan that features a balloon payment. During the initial period of the loan, the homeowner will have low monthly payments or no monthly payments at all. At the end of the loan term, the homeowner will pay off the remaining mortgage in full.


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balloon payment

How Does a Balloon Mortgage Work?

Balloon mortgages can be structured in many different ways. They may have varying terms, interest rates, and maturities. Most balloon mortgages are issued for a period of 5 to 7 years.

Generally, there are three ways to pay off a balloon mortgage:

  • Balloon payments

  • Interest-only repayment

  • No monthly payments

Balloon Payment Mortgage

On a montage with a standard balloon payment, you’ll repay your mortgage loan in monthly increments. Your monthly payment will be much less than what you’d pay on a standard mortgage.

When the loan matures, you’ll make a large final payment (the balloon payment) and pay off the remaining balance. The monthly payments are calculated according to a standard 15 or 30-year mortgage schedule, but the maturity and final balloon payment will be due after about 5 or 7 years.

The amount of the balloon payment will vary, depending on the size of the loan. Usually, it’ll be at least double the amount of all your previous monthly payments combined.

This type of mortgage may also charge interest with each monthly payment.

Example: You take out a 7-year mortgage for $400,000. You make monthly payments of $1,000 and pay $83,000 over 83 months. On the 84th and final month, you’ll make a balloon payment of $317,000.

Interest-Only Repayment

On an interest-only repayment model, you won’t pay back any of the mortgage until the loan matures. Instead, you’ll only pay monthly interest on the loan. At the end of the loan term, you’ll pay the full balance of the mortgage.

Sometimes, the interest rate will be fixed for the duration of the loan. However, some mortgages may use an adjustable rate that fluctuates with market conditions.

Interest-only repayments are beneficial because the interest rate will usually be very low. The drawback is that the balloon payment will be much higher.

Example: You take out a 5-year loan for $300,000. Per a fixed interest rate, you’ll pay $500 interest per month. Over 59 months, you pay $29,500 in interest. On the 60th and final month, you’ll pay off the entire mortgage balance of $300,000.

No Monthly Payments

Some balloon mortgages require no monthly payments at all—not even monthly interest payments. Usually, these types of balloon mortgages are only for a year or two. When the loan matures, you’ll pay off the balance in full, plus interest. The interest tends to be much higher than the interest on a standard mortgage.

This type of balloon mortgage is commonly used for house flipping.

Example: You take out a 1-year montage loan for $200,000. You make no payments for 12 months. At the end of the 12th month, you’ll pay the full $200,000 balance, plus interest.

balloon payment

Balloon Mortgages for Businesses

Balloon mortgages are commonly used by construction companies. It’s a good way for construction companies to obtain short-term financing without having to offer collateral.

Example: A construction company takes out a 2-year mortgage to finance construction on a new building. They may or may not make payments for 2 years, depending on the loan terms. After 2 years, the company refinances the loan with a conventional mortgage and uses the new building as collateral.

Pros of a Balloon Mortgage

A balloon mortgage has several advantages for a prepared investor:

  • Low monthly payments

  • Gives you time to build your finances

  • Good for house flipping

  • Good for a short-term stay

Low Monthly Payments

The most obvious benefit of a balloon mortgage is that you’ll have lower monthly payments until the balloon payment is due. In some cases, you won’t have any monthly payments. Your monthly payments on a balloon mortgage will be much lower than payments on a standard mortgage.

Lower payments make your living situation more affordable and save you money. You can put the money you save toward anything you want: investments, a down payment on a new home, retirement, etc.

Helps You Build Your Finances

Tired of renting? Have a growing family? Can’t immediately afford the costs of a new home? A balloon mortgage can be a helpful way to buy a home if you’re not quite ready to shoulder the costs of homeownership. It’s also a great way to buy a home if your finances (credit score, savings, income, etc.) aren’t quite up to snuff.

As mentioned, a balloon mortgage will reduce your monthly payments to little or none. You can use the savings to better your financial situation—like paying off debt or creating a passive income. You’ll have a solid 5 to 7 years to do this. When it’s time for the balloon payment, you’ll be in a better financial situation to refinance at a lower interest rate (later on, we’ll discuss different ways you can pay off a balloon payment).

Can’t get an affordable mortgage because you have a low credit score? A balloon mortgage can help you buy a home and give you 5 to 7 years to rebuild your credit score. Then you can refinance with a better mortgage at a low interest rate.

Furthermore, if you have a balloon mortgage that requires monthly payments, you’ll be gaining equity in the home as you strengthen your finances, which will also help you gain a low interest rate when it’s time to refinance.

Good for House Flipping

If you’re a real estate investor, you use a balloon mortgage to finance fix-and-flip investments. Investors have to find alternative financing options to buy a fix-and-flip property because most lenders won’t give mortgages on a property that will be paid off in under 10 years. House flippers often use hard money loans, but balloon mortgages have their own unique perks.

Balloon mortgages usually mature within 2 years, so it’s a good fit for house flippers. A no-payment balloon mortgage will give the investor 1 to 2 years to complete the renovation and sell for a profit, and the investor will not have to pay monthly installments. This ultimately reduces the cost of the flip and improves the investor’s return on investment.

balloon payment

Good for a Short Term

Only need a house for a short period? With a balloon mortgage, you can purchase short-term housing for a more affordable month-to-month cost. You can sell the property before the balloon payment.

Pro Tip: This may only be profitable to you if home prices keep rising. If you sell the house for a loss, you may not get enough from the sale to cover the balloon payment.

Cons of a Balloon Mortgage

Balloon mortgages are risky for both homeowners and lenders. Here are some of the risks and disadvantages of balloon mortgages:

  • Can’t make the balloon payment

  • Market decline risk

  • Can be difficult to refinance

  • Not profitable for lenders

Can’t Make Balloon Payment

Your biggest risk as an investor or homebuyer is that you won’t be able to make the balloon payment when it’s due.

If you’re a homebuyer, you might plan on making the balloon payment through savings, refinancing, or selling another property that you own. But anything can happen in the 5 to 7 years before your balloon payment. Your credit score may fall and make it harder to refinance, or you could lose your job and suffer a significant drop in income. These financial changes are easier to manage on a standard mortgage than a balloon mortgage.

If you’re a real estate investor, you might plan on selling one of your other properties to pay off the balloon mortgage, or you might sell the property before the balloon payment is due. But once again, anything can happen in the 5 to 7 years before the balloon payment is due. Housing prices may fall, and you might not make enough on the sale to cover the balloon payment. Or, you may have difficulty collecting rent that’s high enough to cover monthly payments or interest payments.

These are common problems for real estate investors, but—as mentioned before—they’re problems that are easier to manage with a standard mortgage than when you’re faced with a gargantuan balloon payment. If you can’t resolve your financial issues before the balloon payment is due, you could be sunk by it.

Market Decline Risk

To successfully pay off or refinance a balloon mortgage, housing prices should be on the upswing.
If you’re planning on selling the property to pay for the balloon payment, you may take a loss if housing prices are down.

For example, let’s say you took out an interest-only balloon mortgage for $300,000. By the end of the loan term, you haven’t paid off any of the property—$300,000 is due on the balloon payment. Unfortunately, housing prices have fallen and you can only sell the property for $280,000. You’ll take a loss of $20,000.

Refinancing can also be problematic. If the market interest rates are high when your balloon payment is due, your interest rate could increase when you refinance.

Can Be Difficult to Refinance

Balloon mortgages can be difficult to refinance—which is a major risk, considering that many investors depend on refinancing to make the balloon payment.

balloon payment

Refinancing often requires that you hold a minimum amount of equity in the property. If you have a no-payment or interest-only balloon mortgage, you won’t be able to refinance, and you’ll have to turn to other options to make the balloon payment. Or, you’ll have to make a large down payment on the property to refinance.

Not Profitable for Lenders

Thinking about being a real estate lender? Balloon mortgages are not very profitable for lenders, so there aren’t many lenders that offer them.

Balloon mortgages don’t generate a strong cash flow because of their low monthly payments (or their lack of a monthly payment altogether). They may generate some profit when the balloon payment is due, but consider this: there’s a far greater chance of foreclosure. The balloon payment is difficult for many borrowers, even experienced real estate investors.

Balloon Mortgages vs. Other Loans

If you’re looking for a short-term mortgage loan, some alternatives are generally safer or more cost-effective than a balloon mortgage.

If you need financing for house flipping, you might consider using a hard money loan. Hard money loans are usually due within 1 or 2 years. They carry high interest rates, but there are usually no monthly payments, and you can acquire them very quickly (so you can jump on house flipping opportunities when they appear).

An adjustable rate mortgage (ARM) is a solid option for homebuyers. These mortgages will provide you with a low, fixed interest rate for a short period.

Of course, nothing beats the standard 30-year fixed mortgage, which provides the best long-term value and consistency. When you hold a property for a longer period of time, you’re more likely to weather the short-term ups and downs in the housing market.

When are Balloon Payments Due?

Balloon payments are always due at the end of the loan term. Suppose you’re planning on refinancing or selling the property to cover the balloon payment. In that case, it’s important that you get the sale/refinancing process started several months in advance of your balloon payment.

How To Pay Off a Balloon Mortgage

There are two ways to pay off a balloon mortgage: saving and refinancing.

  • Saving: Saving is the most obvious way to pay off a balloon mortgage. It’s easiest for real estate investors—just save a percentage of your property income for your balloon payment.

  • Refinancing: Another common way to pay the balloon mortgage is to refinance the property when the balloon payment is due. To refinance, you need to have built equity in the home (thus, it’s a better strategy for balloon mortgages with monthly payments). If you don’t have enough equity in the home, you may need to make a sizable down payment, which defeats the purpose of refinancing. You’ll also want to manage your credit score so you can a low interest rate.

Is a Balloon Mortgage Right for You?

You should only take out a balloon mortgage if you already have the money to make the balloon payment.

If you already have money to make the payment, you can take advantage of the low monthly payments and rent out the home to create a positive cash flow. When you make the balloon payment, you can continue renting out the property, hold the property for a long period, or sell the property.

Generally, a balloon mortgage is a good way for real estate investors to make short-term profits. If you’re going to employ this strategy, be sure that you diversify your real estate investment portfolio and have properties that generate stable, long-term profits.

balloon payment

Summary

A balloon payment is the final payment of an amortized loan in which the remaining balance is paid off on a lump sum. Balloon mortgages are short-term mortgages that feature a balloon payment. Balloon mortgages carry high interest rates, but also have low monthly payments or no monthly payments at all. Some balloon mortgages only charge monthly interest. Balloon mortgages are very risky because there aren’t many homeowners or investors that can cover a balloon payment. You should only take out a balloon mortgage if you have enough cash to make the balloon payment. Other homebuyers and investors should seek alternatives, like an adjustable rate mortgage.


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