Overview of Balloon Mortgage Loans

Balloon finance mortgages are a mechanism which can be used to substantially reduce the monthly payments required by a mortgage contract. However, there is a catch. At the end of a term, typically, five or seven years, the loan has to paid back in full. Although available, this type of mortgage is not common in the market place. Balloon finance is only suitable where the borrower has made adequate provision for the repayment of capital at the end of the term. Otherwise, the mortgaged property could be at risk.

So, how does it work? Typically, the lender calculates the regular monthly payments that would be required to pay off a mortgage in thirty years. The borrower then contracts to make these payments for a fixed term, typically five or seven years. The borrower also contracts to pay off the remaining loan at the end of fixed term. Thus, at the end of the fixed term, the repayment literally balloons in magnitude. The borrower is expected to put down a large deposit, typically 25% of the property value to secure this type of loan.

Until the end of the fixed period the borrower benefits from low monthly payments because the mortgage is assumed to be redeemed over a long period of thirty years and is usually priced using an attractive interest rate.

Some, but not all balloon mortgages allow the borrower to roll up their loan into a new mortgage product at the end of the fixed term. All borrowers should check whether this is the case before taking out a balloon mortgage. If this route is not pursued the borrower must refund the loan from his or her own resources. This could involve repaying the loan through a cash settlement, or selling the property and using the proceeds.

Plans to repay the loan by arranging a new mortgage facility are not good practice. This practice relies upon the availability of credit at the end of the fixed term. This can not be guaranteed. If the vender is not able to refinance then the property could be at risk.

Balloon finance can be useful to reduce mortgage outgoings in certain circumstances. It is applicable where the borrower strongly expects to come into some money during the term. It is applicable where the borrower expects to sell the property at the end of the term. Commercially, the product is often used by realtors who intend to resell the property at the end of the term.

Property can be at risk if balloon finance is used without sufficient care. Always consider how the loan will be redeemed before contracting for this type of product.