What is a Balloon Mortgage?

A Balloon Mortgage is a mortgage that has a payment term of five to seven years with a payment amount based on thirty years. At the end of the five to seven year period the remaining balance of the mortgage (the balloon) is due. This creates additional risk to the borrower because they must pay the remaining balance on the mortgage, refinance, sell the home, convert to a traditional mortgage at market based interest rates, or foreclose on the home all together. This is referred to as "rollover" risk and can be a major problem if an additional loan can't be acquired to pay off the balloon or the property can't be sold. As a result, the borrower may face bankruptcy even though the property is worth more than is owed on it. That is because the borrower was expecting liquid assets (cash) at the point the mortgage matured.

The advantage of a Balloon Mortgage is cheaper interest rates and easier qualification hurdles than a traditional 30-year Fixed Rate Mortgage. This is a good idea for a savvy homebuyer that may not be able to qualify for traditional mortgages but anticipates being able to refinance or sell the property within the five to seven year period. Choosing a Balloon Mortgage in this situation gives the borrower enough time to increase income, obtain another mortgage, or build equity and sell the home at the end of the seven period.

Another option that is common with Balloon Mortgages is a two-step mortgage, or a Balloon Mortgage with a reset option. The reset option "resets" the Balloon Mortgage into a more common mortgage type at current interest rates and matures in the typical thirty years after the Balloon period is over. This reduces the refinance risk incurred by the borrower and makes it a more viable option.