By Dian Hymer
Usually home buyers take out fully amortized mortgages when financing their home purchases. A fully amortized loan is paid off in periodic payments of principal and interest over the loan term, often 30 years. A balloon payment mortgage is one that has a final payment that is significantly larger than the other periodic (monthly) payments. In some cases, the balloon payment is a substantial amount of money.
Owner-carry back loans often have balloon payments. They are frequently interest-only loans. This means that during the time the buyers are paying on the loan, none of the principal (the amount borrowed) is paid back. So, if the seller carries a $50,000 mortgage for you with interest-only payments, you'll owe the seller the entire $50,000 that you borrowed when the loan comes due.
There are a couple of popular institutional loan products that have balloon payments. One is the 30-year loan that's due in 5 or 7 years. The interest rate on this mortgage product is usually a bit lower than you'll find on conventional 30-year fixed rate mortgages that are due in 30 years. The monthly payments on the short-term mortgages are amortized on a 30-year basis. But, at the end of the 5 or 7 years, a large balloon payment is due.
For example, on a mortgage with a 7.5 percent interest rate, approximately 92 percent of the original mortgage amount is due after 7 years. Let's say you borrowed $200,000 at a 7.5 percent. At the end of seven years, if you haven't already sold the property or refinanced, you'll owe the lender approximately $184,000.
First Time Tip: Make sure if you do take a mortgage that has a balloon payment that the due date doesn't come too quickly. If you can't repay the balance when it's due, you could lose the property in a lender foreclosure.
Some "30-due-in-7" loans have a conversion option. If exercised, the lender extends the mortgage for another 23 years at a new interest rate. The new interest rate is determined according to a conversion formula which varies from lender to lender. The borrower might have to re-qualify for the mortgage if the new interest rate on the converted mortgage is substantially higher than the old rate.
Another popular mortgage these days is a second mortgage for an amount equal to 10 percent of the purchase price. Let's say you're buying a home and need a loan for 90 percent of the purchase price. 90 percent loans often require the borrower to pay mortgage insurance (MI, also called PMI) to protect the lender in case the buyer defaults. If, instead of getting a 90 percent mortgage, you get an 80 percent first mortgage and a 10 percent second mortgage, the first lender often won't require the buyer to pay MI.
Most conventional second mortgage lenders offer loans that are due in 15 years. Since the monthly payments on a fully amortized 15-year mortgage are higher than most buyers can afford, these loans often have monthly payments that are amortized over a 30-year basis. This lowers the monthly payment amount which makes it easier for buyers to qualify for the financing. But, at the end of 15 years, if you were to keep the loan that long, a balloon payment equal to approximately 75 percent of the initial loan amount would be due on a mortgage with a 7.5 percent interest rate.
The Closing: If you're planning to pay a balloon payment by refinancing, don't wait until the last minute. Interest rates fluctuate and future rates can't be predicted with certainty.
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