Balloon Loans

A balloon loan is a loan that is not fully amortized over the loan period. Because the loan is not fully amortized over the term of the loan, a balloon payment is required at the end of the period to fully pay off the loan. The monthly payment is calculated using a 30 year amortization schedule however, the loans are for terms of 5, 7 or 10 years and have fixed rates for the length of the loan period.

Advantages:

• The rates on balloon loans are usually lower than for longer, 30 year fixed loans; reducing the monthly payments. This may mean that you can afford a larger mortgage and therefore buy a larger house.

Disadvantages:

• There is no guarantee that you will be able to refinance at the end of the term. You should consider the balloon loan balance to be due at the end of the term.
• Some types of balloon loans come with a reset option at the end of the term that allows for a resetting of the interest rate and a recalculation of the amortization rate based on the remaining term. The borrower must remember that if interest rates rise they will incur a larger monthly loan payment.

• The borrower knows that they will be moving or refinancing in a short period of time.
• The borrower expects an improvement in their financial situation in the near future. This could be a one time event such as an inheritance or the expectation that their income will increase greatly in the short term.
• A belief that interest rates will decrease and they can then refinance at this lower rate.