Balloon mortgages are short-term home loans that allow borrowers to make small monthly payments — or no payments at all — for several years. After that initial period is over, though, the remaining balance is due in one lump sum.
There are circ*mstances where a balloon mortgage is appealing, but they come with significant risk to both the borrower and the lender. Because of that, it can be difficult to find a lender willing to finance a balloon mortgage.
Here's what you need to know about balloon mortgages, including what they are, benefits and drawbacks and whether or not they're right for you.
What we'll cover
- What is a balloon mortgage and how does it work?
- Types of balloon mortgages
- Pros and cons of a balloon mortgage
- Who are balloon mortgages for?
- Other mortgage options
- Bottom line
What is a balloon mortgage and how does it work?
Unlike traditional 15-year or 30-year mortgages, balloon mortgages have much shorter loan terms, typically just five to seven years.
In most cases, borrowers make small fixed monthly payments, though in some cases no payment is required at all. The catch, however, is that when the initial period is over, you have to make a "balloon" payment — one large installment that covers the remaining balance and any fees
Types of balloon mortgages
There are three common types of balloon mortgages.
No-payment balloon mortgage
With a no-payment balloon mortgage, the borrower typically doesn't need to make a payment for a short period, usually five or seven years, though interest continues to accrue. After that, they must pay the full amount due, plus any interest.
Interest-only balloon mortgage
An interest-only balloon mortgage means the borrower makes monthly payments only on the interest their loan is accruing. At the end of the loan term, they just have to pay back the principal.
Borrowers tend to build equity on their house more slowly with this type of balloon mortgage.
Balloon payment mortgage
With a balloon payment mortgage, borrowers are responsible for paying the interest on a 15- or 30-year mortgage over a much shorter timeframe, typically five or seven years.
Who are balloon mortgages for?
What kind of buyer would a balloon mortgage make sense for? Borrowers who:
- Already have the full payment.
- Plan to sell the home.
- Expect an inheritance or income increase.
- Expect to refinance their mortgage during the loan period.
Since none of these scenarios are guaranteed, there is significant risk involved.
Pros and cons of balloon mortgages
Balloon mortgages have their benefits, as well as many pitfalls. With so much risk, it's important to talk with a financial advisor before deciding if balloon mortgages are right for you.
Pros
- Funds that would otherwise go toward larger initial payments can accrue interest.
- You may get the loan faster than with a traditional mortgage.
- Lenders may be more willing to finance borrowers who don't have good credit.
- You may be able to avoid taking out private mortgage insurance.
Cons
- There's more risk you'll default.
- It's harder to get refinancing.
- If you're only paying interest, you're not building home equity.
Other mortgage options
If you're wary of such a risky proposition, there are other ways for nontraditional borrowers to finance their home purchase. Rocket Mortgage is CNBC's top pick for homebuyers with low credit scores: While a 620 is required for most home loans, Rocket considers applicants with scores as low as 580.
The company offers mortgages as low as 3.5% down and applicants can get pre-qualified online in minutes.
Rocket Mortgage
Annual Percentage Rate (APR)
Apply online for personalized rates
Types of loans
Conventional loans, FHA loans, VA loans and Jumbo loans
Terms
8 – 29 years, including 15-year and 30-year terms
Credit needed
Typically requires a 620 credit score but will consider applicants with a 580 credit score as long as other eligibility criteria are met
Minimum down payment
3.5% if moving forward with an FHA loan
Already have a mortgage through Rocket Mortgage or looking to start one? Check out the Rocket Visa Signature Card to learn how you can earn rewards
Awarded CNBC Select's best mortgage for saving money, SoFi offers up to $9,500 in cash back if you buy your home through the SoFi Real Estate Center.
You can get a mortgage with as little as 3% down and a 0.25% discount is available for signing a 30-year mortgage.
SoFi
Annual Percentage Rate (APR)
Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included
Types of loans
Conventional loans, jumbo loans, HELOCs
Terms
10 – 30 years
Credit needed
620
Minimum down payment
3%
Terms apply.
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Bottom line
Because they're shorter than traditional home loans and require a big lump payment, Balloon mortgages are riskier than typical home financing options. Buyers counting on a change in fortune or to flip the property may want to consider a balloon mortgage, but they should explore other options first.
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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
