A balloon loan is a type of short-term mortgage that can offer a low and level payment during the life of the loan, but then faces a suddenly large payment at the end. This kind of loan does not amortize during its term and the monthly payments don’t add up enough to pay off the remaining principal balance. At the end of the term, this amount must be paid in one lump sum, which is often more than many borrowers are capable of doing.
These loans are an attractive option to some borrowers because of the lower interest rates and longer terms, which gives them the freedom to hold on to more cash over the years. It is important, though, to go into these loans understanding exactly how large that final payment might be and what your options are before the loan term ends.
Many borrowers also seek these loans because they expect to be out of house before the end of the term. Other homebuyers are able to refinance into a new loan, which is an option that has evolved since it can be so hard for the borrower to come up with the lump sum payment. Still, this kind of refinancing can lead to added costs.