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What are the dangers of a balloon mortgage?

On Behalf of | Oct 13, 2022 | Uncategorized |

To say that the real estate market has gone through some rapid shifts over the last couple of years would be a massive understatement. Right now, mortgage interest rates have more than doubled in the last year alone, which is giving would-be buyers pause and sending them scrambling for ways to save.

Cue the return of the “balloon” mortgage. While less popular than they were before the housing market crashed in 2008, they still exist – and the fact that mortgage rates are currently so high has potential buyers looking at them once more.

What’s a balloon mortgage?

Most mortgages amortize the principal and interest of a loan over 15 or 30 years, so that you make fixed monthly payments the entire time.

With a balloon mortgage, you commonly only pay the monthly interest on the loan (which can be calculated according to that customary 15-30 year schedule) and nothing toward the principal. Some balloon mortgages even allow you to pay nothing at all for a year or so.

So, what’s the catch? Well, the entire balance of the loan becomes due in one lump sum after a fixed period of time, whether that’s a year, three years or even seven.

Why would people choose a balloon mortgage?

Coming up with a lump-sum payment that potentially runs into the hundreds of thousands of dollars all at once doesn’t really appeal to anybody, so why do people use balloon mortgages?

Well, many people are banking on interest rates dropping in the near future, which would allow you to refinance your home at a reasonable cost before the balloon payment comes due. Others are hoping to improve their credit before that time and save up for a hefty downpayment, which can also allow you to refinance into a conventional loan.

Obviously, the biggest danger of a balloon mortgage is that things simply won’t go as you anticipate. Interest rates could go even higher. Property rates could fall, putting you upside-down in your loan. You could run into unexpected financial problems and be unable to save anything at all.

When you’re buying a home, it’s wise to consider all the possibilities. It’s also wise to make sure that you have experienced legal guidance to review any contracts so that you know exactly what you’re getting.