Does Anyone Really Ever Get a Balloon Mortgage? How Come I’ve Never Been Offered One?
Yes, there are still a significant number of balloon mortgages issued every year in the United States. The reason you’ve probably never encountered one is because they are more commonly used to finance commercial real estate, and are rarely used when borrowers are purchasing homes.
Balloon Mortgages are Extremely Risky
Balloon mortgages are an extremely risky type of mortgage that residential borrowers should avoid at all costs. The provisions of this contract allow for an extremely short loan term, typically between 5 and 10 years, however the monthly payments are not designed to pay back the entire principal during that time. In fact, the monthly payments are based on a hypothetical 30-year fixed loan. What this means to the borrower is that the payments he’s making every month are usually just barely enough to cover the interest on the loan, and sometimes not even that.
Options for Balloon Mortgage Borrowers
The end result is either Negative Amortization or an unpaid principal balance at the end of the term that is still exactly the same as the day the loan was originated. Balloon loans require the borrower to then pay the entire balance of the loan in one lump sum, regardless of how high the balance is at that time. There are only a few options for the borrower here, and they are:
1) Pay the balance in full with cash reserves;
2) Refinance the outstanding balloon balance with another company into another loan; or
3) Exercise one of the provisions of the balloon contract (if one exists) that allow for the continuation of the loan under a different set of terms.
The first two options described above are simple and easy to comprehend, however the last option could use some additional clarification. Many balloon mortgage contracts contain a feature that the borrower can activate, provided he has met certain qualifications, that allow for a complete adjustment of the terms of the loan and essentially change the balloon loan into a traditional 30-year fixed loan. Some of the more common criteria for eligibility of activation of this feature include such things as no late monthly payments within a pre-defined time period, a certain credit rating, and a specific minimum level or amount of cash reserves. If the borrower can demonstrate that he has met all of these requirements, then the mortgage company will be obligated to fulfill their end of that clause and change the details of the contract per the existing limitations of the balloon.
It is important to also explain that every provision of the “new” loan that results from the conversion of the balloon has been pre-determined and agreed to by both the borrower and the lender, therefore neither can claim to be surprised or uninformed. The only variable that is left to chance is the effective interest rate of the new loan, since this will usually be determined by assessing the current prime rate and applying the lender’s formula.
