A balloon mortgage is a loan in which a large portion of the principal is repaid in one payment at the end of the term. Investors use a balloon mortgage to qualify for a higher loan amount, lower rates and lower monthly payments. Balloon mortgage rates typically start around 4.5 percent with 5- to 7-year terms.
What a Balloon Mortgage is & How it Works
A balloon payment mortgage is basically a loan that has a short-term between 5 – 7 years but is amortized across 30 years. At the end of the loan term, a lump sum called a balloon is due. Balloon mortgages vary greatly because they’re not conforming and don’t have to adhere to strict guidelines like conforming loans. Some balloon mortgages are interest-only for the term, and others require interest and principal payments. Generally, all balloon payment mortgages have fixed rates, short to medium loan terms and have a lump sum due at the end.
Lenders that offer balloon mortgages generally consider them a low-risk loan because they only approve people who they feel can afford to pay the lump sum when it becomes due, or who have a solid exit strategy in place, either refinancing or selling the property.
Because of this low risk, the savings are passed onto the borrower through a competitive interest rate, a low down payment — generally of 10 percent or less — lower monthly payments and more lenient borrower qualifications. The low rate and low monthly payments may be tempting but remember that a large lump sum is due at the end of the term, and you need to be sure you can pay it, refinance the loan or sell the property.
Some lenders offer a type of refinance option when they approve a borrower for a balloon mortgage, and this is called a reset option. This means that at the end of the term, the amount that’s owed, known as the balloon, will reset at the current interest rates. Not all lenders offer this, and you don’t know what rates will be in 5 to 7 years so make sure you talk to the lender about this option before making a decision.
Some risks that may take place with balloon mortgages include:
- Declining property values
- Fluctuating market trends
- Changing mortgage rates
- A decline in personal finances
Who a Balloon Mortgage is Right for
A balloon mortgage is considered a specialty loan product, and it’s not right for everyone. Generally, a balloon payment mortgage is right for an investor that has a clear exit strategy in mind and knows how he or she will pay off the mortgage. It’s also right for an owner-occupant who is expecting a lump sum of money before the balloon payment is due.
Typically, a balloon mortgage can be right for:
- An owner-occupant who wants to purchase a property that otherwise may be out of their price range and an owner-occupant who plans on living in the area for a short time but expects rapid property value appreciation
- An owner-occupant or investor who has a low salary but high commissions or bonuses
- An investor who wants to purchase a property, rehab it and then rent it for a few years before selling it for a profit, at which time they will be able to pay off the balloon
- A buy and hold investor who wants to take advantage of a lower interest rate and a lower monthly payment and who plans on selling or refinancing the property before the balloon is due
- A commercial real estate investor who wants a balloon mortgage with low payments so they can increase their cash flow and refinance the property before the balloon payment is due
- A builder or developer who uses a balloon mortgage on another property to finance a construction project and then pays it off once they sell the project or refinance into a permanent loan
A balloon mortgage is generally not right for a fix-and-flip investor because the average balloon mortgage term is 5 to 7 years and a fix-and-flip investor usually holds a property for 6 months or less and wants an interest-only loan that finances the acquisition and rehab of a property. It’s also not right for you if you’re unsure of how you would pay off the balloon portion of the loan.
Balloon Mortgage Rates & Fees
Balloon mortgage rates typically start at 4.5 percent for prime borrowers, regardless if you’re an investor or owner-occupant. Balloon mortgage rates are generally about a half to three-quarters of a point lower than conforming loan interest rates. This means that the balloon mortgage monthly payments are typically lower than conforming loan monthly payments. Balloon mortgages typically don’t have prepayment penalties, which adds to their appeal for certain buyers and investors.
Balloon mortgage rates are typically:
- Balloon mortgage rate: 4.5 – 5.5%
- Appraisal: $500+
- Closing costs: 2 – 5%
- Prepayment penalty: Typically none
Lender fees vary by lender but include things like an application fee which is usually a few hundred dollars and an origination fee, which is generally 0.5 to 1 percent of the loan. Some balloon mortgage lenders charge the borrower points in exchange for a lower interest rate. One point represents 1 percent of the loan and lenders may charge 0 to 2 points, which are a one-time fee paid during closing.
Balloon mortgages are non-conforming, meaning they don’t meet the loan purchasing guidelines of the Federal National Mortgage Association (FNMA), so they’re not sold on the secondary market. This also means the balloon mortgage lenders can be more flexible when it comes to rates and fees. If they think that a borrower has a solid plan for repaying the balloon payment, they consider the loan fairly low risk because the monthly payments are relatively affordable.
Balloon Mortgage Terms & Qualifications
A balloon mortgage is a specialty loan product that has different terms and qualifications depending on the lender offering it. However, common terms are 5 to 7 years, although some credit unions offer 10- and 15-year balloon mortgage loan terms. Qualifications also vary by lender, but typically a lender requires a credit score of 620 or higher.
Balloon mortgage terms and qualifications are typically:
- Term: Average loan term is 5 to 7 years with a few lenders offering up to 15-year terms
- Credit score: 620+ (check your score free here)
- Down payment: Typically, 10 percent or less of the purchase price
- Exit strategy: The lender wants to know how you’re going to pay off the balloon when it becomes due; this is typically done by refinancing or selling the property or paying it off with an expected lump sum of money
- Bank statements: The lender will generally ask for 3 or more months of bank statements to see cash reserves, but there isn’t an exact amount that they require
- Overall financial standing: The lender generally doesn’t require a certain amount of cash reserves but instead wants to see your overall financial picture including your debt, income and length of employment
Keep in mind that balloon payment mortgage qualifications do vary and aren’t as stringent as conventional loan qualifications. They don’t tend to have standard requirements and instead focus more on the lender’s comfort level with the borrower’s finances, the property and the property location.
Balloon Mortgage Example
Let’s take a look at an example of a balloon mortgage. Let’s assume we have a property that is valued at $500,000, an interest rate of 4.5 percent and a term of 7 years. The loan will be amortized over 30 years instead of the 7-year term, making the monthly payments more affordable.
In this example, the monthly payments will be $2,533.43, and the balloon payment is $437,664.53, which means this amount will be due at the end of 7 years. The total interest paid will be $147,939. This is less than half of the interest you would pay on a conforming loan.
In this scenario, you would either need $437,664.53 cash or to refinance with another 15- or 30-year mortgage and pay additional fees and interest. Alternatively, you would need to sell your home to pay off the balloon loan payment. Keep in mind that interest rates, property values and your personal financial situation could have changed in your favor or against you.
Now, let’s compare this to a conforming 30-year loan, using the same interest rate and same property value. Your monthly payment will be the same $2,533.43 and, as the years go by, more of the payment will be applied toward the principal and less towards the interest. Your total interest paid will be $412,033.56. You can see you will pay substantially more for a conforming mortgage, but you have 30 years to pay it off. However, if you refinance the balloon mortgage, the difference could be essentially eliminated.
Where to Find a Balloon Mortgage
As we mentioned above, a balloon mortgage loan is no longer a popular type of loan for homeowners or investors. After the recession of 2007/2008, many lenders stopped offering balloon mortgages due to increasing regulatory laws such as the requirement for a borrower to meet the ability to repay. With that being said, there are a couple of lenders that still offer balloon mortgage loans, and we include some of the best options below.
Two balloon mortgage lenders include:
PenFed Credit Union is a nationwide credit union and mortgage lender that offers loans to its members in all 50 states. It offers a 10-year balloon loan mortgage with rates starting at 4.5 percent. It offers balloon payment mortgages for real estate investors who want to rent out their property, renovate it and then rent it or buy and hold it for a few years before reselling it. A minimum credit score of 620 is usually required to qualify for a balloon mortgage at PenFed. You can contact them on their website and apply online.
Columbia Credit Union offers mortgages in Washington state and Oregon. It offers something called a 30/15 balloon mortgage, which is a balloon mortgage loan amortized over 30 years, but the balloon payment is due at the end of 15 years. It’s a fixed rate mortgage with a balloon mortgage rate starting at 4.35 percent. It can be used for an owner-occupant or a real estate investor. You can contact them on their website and apply online.
How to Apply for a Balloon Mortgage in 4 Steps
You can apply for a balloon mortgage by choosing a balloon mortgage lender, getting pre-approved, beginning the underwriting process and, finally, you close on your property using a balloon mortgage. After you find out if a lender offers a balloon mortgage, you should look for a few other balloon mortgage lenders so you can compare balloon mortgage rates, terms and qualifications.
Generally, the four steps to applying for a balloon mortgage are to choose a balloon payment mortgage lender, get pre-approved for a balloon mortgage, begin underwriting process for your balloon mortgage and close on your balloon mortgage.
1. Choose a Balloon Payment Mortgage Lender
After you decide that a balloon payment mortgage is right for you, you should choose a lender to work with. This is the first step in the application process and is important because a lender that offers a balloon payment mortgage is hard to find. It’s a good idea to compare two or three lenders and their rates, terms, qualifications and what areas they lend in. Unfortunately, balloon mortgages aren’t as prevalent as conforming mortgages so they may be more difficult to find.
Look for reputable lenders that lend in the area you want to purchase a property in. It’s a good idea to start with your bank or credit union because you already have a banking relationship with them so may get better rates and more lenient qualifications.
2. Get Pre-approved for a Balloon Mortgage
Getting pre-approved for a balloon mortgage is generally the most important step of the approval process. This is because it lets you know the maximum amount you can qualify for, which can steer your property search and help you set your budget.
Remember that the pre-approval amount should be considered the very top of your price range and you need to make sure you can afford the property and all associated expenses like homeowners’ association fees, maintenance or utilities.
This is also the step when the lender gives you a pre-approval letter, which is required before making an offer on a property. It shows the real estate agent and the seller that you’re a serious buyer that can afford to purchase the property.
The preapproval process usually takes one to three business days, and the lender will run your credit, and request documentation of proof of income such as pay stubs, bank statements and/or tax returns. Each lender has a different pre-approval process, and whatever they don’t ask for during the pre-approval phase, they will want to see during underwriting. You should ask the lender up front what documents they require and when they need them so you’re prepared.
3. Begin Underwriting Process for Your Balloon Mortgage
After you get pre-approved for a balloon mortgage, it’s time to submit any outstanding documents and go through the underwriting process. This is the time when the lender will examine your proof of income, go through your entire credit report and look at your debt-to-income ratio. During this time, the lender will order an appraisal to see how much the property is worth. The appraisal fee usually needs to be paid out of pocket and is around $500.
The lender may want to see documents such as 3 to 6 months of bank statements, 2 years of tax returns and your two most-current pay stubs. Each lender has a different underwriting process, and they generally look at the borrower’s overall financial standing, the property value and the location.
The lender also wants to know how you’re going to afford to repay the balloon payment and wants to see an exit strategy such as an upcoming bonus, property sale, inheritance or a substantial salary increase. Other exit strategies could include selling the property if it’s expected to increase in value or you’re rehabbing it to gain sweat equity.
4. Close on Your Balloon Mortgage
The final step is to close on the loan which is typically 30 to 45 days from the time you apply for the balloon mortgage. During this step, the lender reviews the property appraisal and issues you a mortgage approval. Once you receive this approval, you can schedule the settlement and the title company generally sends out a closing notice to all parties with the date and time of settlement.
The actual settlement usually takes about 60 to 90 minutes and is held at the title company’s office so they can copy all documents and give out signed copies. You need to bring your identification and a certified check. This is the time when you will pay the closing costs which are typically 2 to 5 percent of the purchase price, and the lender will give you a breakdown of them ahead of time. After you give your check or the funds are wired, you sign the loan documents, and the deed is transferred to you, you get the keys to your new property.
Balloon Payment Mortgage Pros & Cons
Balloon mortgage pros and cons should be evaluated before deciding if a balloon mortgage loan is right for you. A balloon payment mortgage may offer lower rates and lower monthly mortgage payments than a conventional permanent mortgage. However, you have to be sure that you can afford the lump sum payment due at the end of the loan term.
Balloon mortgage pros include:
- Lower interest rate than conventional 30-year loans
- Qualifying for a property you may not qualify for with a conventional loan
- A lower down payment which is generally 10 percent or less of the property’s sale price
“Balloon mortgages are a good tool if you are fairly certain of how long you will need the financing for. Usually, they offer a lower interest rate with the full balance remaining being due by a certain determined time. Investors sometimes use them on new real estate projects that they plan on selling quickly, and/or fixing and refinancing to get their cash investment back as well as pay off the loan before it balloons.” — Ralph DiBugnara, President, Home Qualified
Balloon mortgage cons include:
- The property not appreciating as expected so no available equity
- Not being able to pay the lump sum and being foreclosed on
- Not being able to sell the property before the balloon payment is due
- The property not selling before the balloon payment is due
Alternatives to a Balloon Mortgage
A balloon mortgage has attractive low monthly payments and lenient qualifications, but you need to be sure you can repay the lump sum due at the end of the loan term, by paying it off, refinancing the property or selling it. If you’re not sure that a balloon mortgage is right for you, there are some alternatives including a conforming loan or a line of credit.
Alternatives to a balloon mortgage include:
- Adjustable rate mortgage (ARM): This is a type of mortgage where the interest rate is initially fixed for a period of time; then, after that period of time is over, the interest rate resets. ARMs are usually 5/1 or 7/1 meaning they’re fixed for 5 or 7 years and then can adjust once a year afterward for the duration of the loan; typically, ARMs are used by investors and owner-occupants to payer lower interest during the initial period of the loan
- Rehab loan: A loan to acquire and rehab a property before you flip it
- Jumbo loan: A loan over the conforming loan limit of $453,100 that can be used to purchase an investment property or a primary residence
- Investment property line of credit: If you have 40 percent or more equity in another property, then you can use this to purchase the new home or as down payment funds
- Hard money loan: An alternative to a rehab loan which also funds the acquisition and rehab of an investment property
- Cash out refinance: Take cash from another property and use it to purchase the new property or as down payment funds
- Seller financing: The seller agrees to accept installment payments from the buyer, so the buyer doesn’t have to go through a bank, but the terms and conditions vary widely
Balloon Mortgage Calculator
A balloon mortgage calculator does the work for you. It helps save you time from having to use a regular calculator, by hand calculations and an amortization table. Instead, you input data like the price of your property, down payment, mortgage amount, interest rate and loan term.
The balloon mortgage calculator calculates your monthly payment, shows you how much your balloon payment will be and the amount of interest you paid over the term of the loan. The balloon mortgage calculator can be helpful in deciding if a balloon mortgage is right for you.
Balloon Mortgage Loan Frequently Asked Questions (FAQs)
Below, we answer some of the frequently asked questions about balloon mortgage loans. If you have additional questions or would like to comment on the topic, please visit our forum.
What is the Difference Between an Adjustable Rate Mortgage and a Balloon Mortgage Loan?
An ARM is a mortgage that has an interest rate that adjusts after a certain period of time. However, the loan isn’t due until the end of the loan term, and there’s no balloon payment. This is in contrast to a balloon mortgage that has a lump sum due at the end of the term.
For example, if you have a 5/1 ARM, it means that your rate is fixed for the first 5 years of the loan. After that, the loan can adjust once per year for the remainder of the loan term. However, a balloon mortgage loan generally has a fixed rate that is amortized over 30 years, but the term is generally between 5 to 7 years. At the end of the term, a lump sum is due, called the balloon.
What is the Difference Between a Balloon Mortgage and a Hard Money Loan?
A balloon mortgage can be interest only or interest plus principal. It’s typically for 5 to 7 years and has a balloon payment due at the end of the term. In contrast, a hard money loan is usually an interest only loan for 6 months to 2 years. Instead of a balloon being due at the end of the term, the entire amount of principal is due at the end of the term and is usually paid off by flipping or refinancing the property.
If you’re looking for a hard money loan to finance a fix-and-flip property, contact LendingHome. They’re a reputable nationwide lender that offers competitive rates to prime borrowers. They can prequalify you online in just a few minutes.
What Does a 5-year Balloon Mean?
A 5-year balloon means that the balloon mortgage loan term is for 5 years, but it’s typically amortized over 30 years. This means that the borrower will have a fixed rate with set mortgage payments for 5 years and at the end of the 5-year term, a lump sum is due. Because the loan is amortized over 30 years, the monthly payments tend to be lower than a conventional 30-year mortgage.
Can You Refinance a Balloon Mortgage?
You can finance a balloon mortgage, and there usually aren’t any prepayment penalties. Generally, a balloon payment mortgage is refinanced off, the property is sold or the lump sum payment is made to pay off the loan. A borrower may opt to refinance the balloon mortgage loan to a conventional loan to avoid having to pay the large lump sum due at the end of the term.
The Bottom Line
A balloon mortgage is a loan that is generally for 5 to 7 years and has a lump sum due at the end of the loan term. A balloon mortgage rate typically starts at 4.5 percent. Investors and owner-occupants use balloon payment mortgages to take advantage of low rates, monthly payments and to qualify for a more expensive property than they would qualify for with a conventional loan.
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