What is a Balloon Mortgage and How Does It Work?
In an effort to help you be more aware about the mortgage options you have available to you, we are now going to discuss Balloon Mortgages. It is important to know what is going on in the world of mortgages, just so you do not get left behind. You always need to make sure you are doing the best thing possible for you. That means learning about all the options out there. So here is a little bit about a balloon mortgage.
How Does a Balloon Mortgage Work?
A balloon mortgage is actually not that far off from a fixed rate mortgage. In fact, the payments are both calculated in the exact same way. The payment will be the amount required to pay off the loan over the 30 year period. But the difference is that after a certain period, which will usually fall between 5 and 7 years, the outstanding balance will need to be paid off in full. This is called the balloon, which is where balloon mortgage comes from.
Well that seems inconvenient one would think. If the borrower is still in the house wouldn't that cause troubles? It is highly unlikely one would have the funds to pay off the balance at that exact moment. Well, the answer comes with refinancing. Then you will get the current market rate on the refinancing.
Some even say a balloon mortgage is like an adjustable rate mortgage. This is because of the set time for a fixed rate followed by a period where the rate can be adjusted. It is comforting to pull in the similarities between a balloon mortgage and a FRM or ARM. Here are some of those similarities, along with some differences.
Balloon Mortgages vs. ARM
Balloon mortgages are usually as simple as an ARM can be. You will need to pay off the entire loan at the 7 year mark by refinancing, but then you will have a different rate for the new loan. This rate will be adjusted. But an ARM can be more difficult, because the rate adjustment comes as part of the contract. So it can be a little more troublesome to handle. ARMs are often a done deal though, which causes less trouble because you are locked into a contract. The lender cannot get penalty happy if you are a bad payer. With a balloon mortgage, you need to pay in 7 years and often times the rate you get hurts your credit a bit. Then there is the matter of refinance costs with a balloon mortgage, and that is something no one enjoys. The main thing however is that an ARM provides you with protection against an interest explosion. High rate rises means really balloon rises. This is very rare though.
In the end however you need to do what you think is best. A balloon mortgage is, however, a very great option if you did not figure to be in the house very long. Very long equals 5 to 7 years. You do get a price advantage with a balloon mortgage. But if you are not sure about where you will be in 7 years, then you may not want to risk getting stuck with a very large payment and refinancing costs.
