What Is A Balloon Mortgage In Real Estate?

In the current real estate market, more and more homebuyers are looking to explore their loan options, according to a recent report from CNBC. A variety of mortgage options exist for these buyers. We've previously discussed a few other examples including the assumable mortgage and the graduated payment mortgage. Another type of mortgage is a balloon mortgage.

Balloon mortgages have low initial payment requirements. This can mean low monthly payments or even interest-only payments. Then, at the loan's conclusion, the borrower is expected to pay the full balance as a lump sum. This type of mortgage gets its name because of the ballooning price when the ultimate payment is due. The final payment is usually substantially larger than the borrower's earlier payments. Investopedia notes that balloon mortgages tend to have short terms, sometimes as low as two years, but typically lasting five to seven years. In today's market, balloon mortgages are less common than other loan options. They decreased drastically in popularity following the Great Recession, according to Lending Tree.

Balloon mortgage dynamics

These types of mortgages have certain benefits, burdens, and risks, as noted by Investopedia. Given their short-term requirements, balloon mortgages may appeal to homebuyers who plan to have their homes for shorter periods of time. Since the loan is typically paid off in five to seven years rather than 20 to 30 years, it can drastically reduce the overall cost for buyers. However, from both a buyer's and lender's perspective, these mortgage types can be considered risky investments.

As Investopedia notes, these mortgages may include fixed or variable interest rates. A fixed interest rate ensures the buyer that their interest rate will remain consistent throughout the duration of the home loan terms. Buyers who seek economic certainty and like to budget strictly might prefer fixed-rate mortgages. On the other hand, variable interest rates can fluctuate. They typically include lower monthly rates initially, but they can change with the market, so if interest rates go up, so will your monthly payment.

Interest rates are especially important to note in balloon mortgages because they often include interest-only monthly payments. These interest-only payments can equip homebuyers to sign on for the required low payments before rendering their full lump sum upon its due date.