Balance Due At Maturity
The conventional residential real estate mortgage has a structure, which includes monthly repayments of principal and interest, where the payments over the term of the loan pay off the principal entirely, and nothing is due at maturity. In other lending instruments, such as corporate bonds, the borrower has to make payments of interest, called coupons semi-annually, and the full balance becomes due when they reach maturity.
Balloon payment mortgages have features that make them intermediate between conventional amortizing home loans and bonds. The balloon is the balance that becomes due at maturity. The advantage that you get from this type of mortgage is that your payments will be lower, in the same way that an adjustable rate mortgage. The difference is the risk of not being able to make the balloon payment when it comes due.
Loans That Grow Up Too Soon
Lenders calculate the payments based on a long-term amortization, but the mortgage come due at a date considerably earlier than it would take to pay it off. That means that at the end of the term, you will have to pay the outstanding balance. The balloon is the large final repayment of principal.
If you have a seven-year term with a thirty-year amortization and a balloon payment it will be less expensive the same a loan with a seven-year amortization, but then so will an adjustable rate mortgage. ARMs tend to have much less painful adjustments than the balance due at the end of a balloon loan.
Emulating Commercial Real Estate Lending Practices
You make a few assumptions if you agree to a balloon payment. You assume that you will have the payment, one way or another. Perhaps you have the capital, but you don’t want to tie up in something as illiquid as real estate. Or you are very confident that you will be able to sell at a profit when the loan comes due.
This type of funding is more popular in commercial real estate; making a balloon payment is less of a concern if the property is merely one in a much larger portfolio of investments. As with most financial obligations, you will benefit most if you are in a position of strength; things cost less in the long run if you have the capital assets to back your choices.
Selling Balloon Property Tricks
Lenders also benefit from the balloon payment; they always prefer to receive payments sooner rather than later. The risk of investing extends along with the period of the loan so that on average, loans that pay back capital faster represent a smaller risk. To encourage consumers to take on balloon mortgages lenders will sometimes offer a version that gives the option of a reset at maturity.
Choosing a balloon mortgage is one option to finance your home. However, it is a less appealing option arguably than an ARM if you need the low payments. A 5/1 ARM will reset but rather than a struggle to cover a balance due at the risk of foreclosure; you might just have to scramble to find a larger but manageable monthly payment. If you can make larger payments and wish to pay less over the long-term, you will get greater benefit from a fifteen-year repayment loan.