Balloon payments are a method of financing your home or making other major purchases. They involve paying little or nothing at the beginning of the loan period and making a larger payment at the end of the contract. This is a great option for people who have a good credit score and would prefer to save their money until a later date. To help you decide whether this is the right option for you, this article explains how balloon payments work and reviews the advantages and disadvantages of this type of loan. With this information, you can determine whether this opportunity fits your needs and goals. Then you can compare mortgage rates and find the offer that matches your budget.
How balloon payments work
When you agree to a balloon payment mortgage, you are choosing to make small payments throughout the loan term or delay making payments altogether. Sometimes these agreements ask you to only pay the interest on your loan throughout the payment term, meaning your costs are very low for most of the mortgage period.
At the end of this term, you are expected to pay the rest of the principal loan. Because you have been paying little to nothing until the end of your contract, you would have to pay a large portion of the total expense as a lump sum. This means you have an opportunity to save at the beginning but would need to be prepared to pay a large sum during the final stages of the mortgage.
Two main balloon payment options
There are two primary options to choose from when creating a balloon payment agreement. These choices offer different arrangements for borrowers to pay off their mortgages.
- Borrowers pay small parts of the principal loan along with interest throughout the mortgage period. They would make these payments each month until the term ends, referred to as the maturity date. Once the loan matures, they pay the rest of the costs to end their mortgage agreement.
- Borrowers only make interest payments during the mortgage term and pay the entire principal at the end.
Both of these options allow for initial savings and require larger payments to wrap up the mortgage. Deciding between these options involves choosing how much you want to save at the beginning and how much you will be capable of spending at the end. Sometimes you can mix the two choices, with only interest payments for the first couple of years and then small principal payments beginning at an agreed-upon time.
Balloon payment examples
There are a variety of ways to arrange balloon payment mortgages. For example, you might buy a $500,000 home with an amortization period of 10 years. That means that you have 10 years to pay it off through regular payments. With a balloon payment mortgage, you could choose to make small principal payments of $1,500 per month for the full 120 months, amounting to $180,000. Then at the end of this period, you would make a balloon payment of $320,000 to pay off the remaining amount. Alternatively, you might have an arrangement where you pay $100 in interest each month and pay the full $500,000 principal at the end.
How to make a balloon payment
There are three main ways you can make a balloon payment at the end of your mortgage term. These strategies will depend on your specific circumstances.
Using your savings
If you have the money saved, you can pay the final lump sum using funds in your bank account. This is the easiest and simplest way to fulfill your mortgage contract and settle the loan.
If you choose not to make the balloon payment with your existing funds, you may be able to refinance your mortgage loan to help raise the money. This requires that you have good equity in your home and a reliable credit score. The new mortgage will likely follow a more traditional monthly payment schedule.
Selling the house
Some people sell their home to pay for the rest of the mortgage costs. This may be out of necessity, or it may be something they planned to do all along. This is an option that is frequently used by people who flip houses, relying on rising property values to make a profit.
Balloon payment pros and cons
There are many different reasons why borrowers agree to a balloon payment mortgage. The following is a list of pros and cons to help you decide whether this option will work for you.
- There are low monthly costs because you have to pay little of the principal for most of the loan term.
- You can buy a house even if you don’t have large savings at the beginning.
- If you are not making high wages currently but expect to have a higher income in the future, the lower initial costs will place less strain on your finances.
- You can often avoid high monthly interest rates if you are making only small payments each month.
- You will have to make a much larger payment at the end of the loan period.
- There are significant risks with deferring a large payment until the end if you cannot save the required amount.
- If housing prices fall, it will be more difficult to get the full value from selling your home, making the loan payment more challenging.
- If the loan follows an interest-only payment schedule, these payments could fluctuate significantly if you do not have a fixed-rate agreement.
Balloon payment mortgages are a great way for many people to finance their homes. They involve making lower payments at the beginning of the mortgage agreement and a large payment at the end, giving homeowners the chance to save their money until a later date. While there are many advantages to these contracts, there can also be significant risks. By weighing the pros and cons of balloon payments, you can decide whether this option makes financial sense for you.