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The balloon mortgage is named after the ballooning nature of payments - small and fixed initially and much larger after the prescribed period. What are the features of a balloon loan? What are the pros and cons of opting for a balloon mortgage? Find out answers to these and more!
In a balloon mortgage, the principal and interest payable are calculated as if the term of the balloon loan is 30 years. But typically the actual term of a balloon mortgage is much shorter, about 5 or 7 years. At the end of this period, a lump-sum payment has to be made to the lender for the outstanding balance on the balloon mortgage. This can be done with a refinancing option too. What are the factors that must be taken into account when considering a balloon mortgage?
The balloon loan is usually for a short period
The interest rate is usually lower than a conventional mortgage
Qualification for a balloon mortgage is easier
Monthly payments for period of balloon loan are fixed and usually lesser than those on a conventional mortgage loan
The outstanding balance on the balloon mortgage looms large at the end of the prescribed period for settlement.
Balloon mortgages are popular with people who have definite intentions of selling the house before the balloon payment comes up for settlement. This happens with the case of persons on frequent transfers. A balloon loan is suited for those who relocate often or plan to stay in their home for less than seven years Some people use balloon loans to better leverage their money. The low capital outlay in the initial years allows you to better utilize the available capital for the life of the loan. But good financial planning is called for since a large payment stands due at the end of the loan period.
The options available to a homebuyer at the end of the balloon loan period are:
Selling the house
Converting balloon mortgage to conventional mortgage loan.
In a balloon mortgage, the homebuyer pays equal monthly payments at a fixed rate of interest for the period. Since the interest rate is usually lower than market rate, the payment is typically lower than on a conventional mortgage. If you convert the balloon mortgage to a conventional mortgage, you can qualify automatically and need not go in for re-approval. The interest rate prevailing then is used to calculate the conventional mortgage.
5/25 and 7/23 convertible balloon mortgages are taken up by many homebuyers as viable options at the end of the balloon loan term. A 7/23 balloon mortgage indicates that the period of the balloon loan is 7 years and there is 23 years worth of principal. A balloon mortgage calculator can help in accurately estimating your initial fixed payments and the possible conversion scenarios. The interest rate must also be considered at the time of converting the balloon loan to a conventional home mortgage loan. With interest rates hitting all-time lows, there is no guarantee that they will stay that way for the next 7 years.