Balloon Loan

7 Year Balloon, 5 Year Balloon, 3 Year Balloon

Balloon loans are short-term mortgages that have similar features to a fixed rate mortgage. The loans provide a constant payment feature during the specific term of the loan, but contrary to the 30 year fixed rate mortgage, balloon loans do not fully amortize over the loan term. Interest rate and payment stays the same until the loan is due. Characteristically, the entire loan amount is due in 3, 5, or 7 years.

At the end of the loan term the remaining balance is required to be paid in full. This can be accomplished by paying in cash or refinancing the loan. Many lenders provide other options such as a conversion feature at the end of the loan term. For example, the loan may convert to a 30 year fixed loan at the thirty-year market rate plus 3/8 of a percentage point. The balloon mortgage program with a conversion option is often called a 7/23 Convertible or 5/25 Convertible.

Balloon type loan programs are usually recommended for borrowers who are certain that they will be leaving their current house in 3, 5, or 7 years, or are going to refinance the loan.

Advantages:

One of the advantages of a balloon loan is that they tend to have the lowest interest rate and therefore lowest mortgage payment for the balloon period.
Lower initial monthly payments with option to refinance at the end of the term period.
Many balloon mortgages offer the option to convert to a new loan after the initial term.

Disadvantages:

The entire balance must be paid off or refinanced at the end of the term.
Higher interest rates at the end of the balloon loan could prevent you from qualifying for a new mortgage.
Risk of foreclosure if you cannot make the balloon payment, if you cannot refinance, or if you cannot exercise the conversion option.