Affiliate links for the products on this page are from partners that compensate us (see our advertiser disclosure with our list of partners for more details). However, our opinions are our own. See how we rate mortgages to write unbiased product reviews.
- With a balloon mortgage, you start by making monthly payments, then pay the rest in one lump sum.
- Regular mortgages require you to pay off the amount you borrow in installments for up to 30 years.
- Balloon mortgages can be risky because events could stop you from making the lump sum payment later.
Thanks to high mortgage rates and home prices, mortgage payments have been rising in recent years. One way to snag a lower payment is to explore alternative loan options — like adjustable-rate loans or, less commonly, balloon mortgages.
These loans can offer you lower monthly payments, but they come with some notable risks. Here's what to know about balloon mortgages and when you may want to use one.
What is a balloon mortgage?
A balloon mortgage is a type of loan you can use to buy a house. They're not very common, and most lenders don't offer them, but they can be an option for some buyers.
Definition and basic concept
The main difference between a balloon mortgage and a regular mortgage is your payment structure for paying off the mortgage principal, or the amount you borrow to buy your home.
Most types of mortgage loans require you to make monthly payments toward both the principal and the interest, so you gradually pay down your mortgage over a set amount of time, such as 30 years.
But with a balloon mortgage, you make smaller payments each month. At the end of the mortgage term, you pay off the remaining principal in one lump sum.
How do balloon mortgages work?
Each mortgage lender operates differently, but it's likely your balloon mortgage would look one of two ways:
- You only pay interest each month, then pay the entire principal amount when the lump sum is due. If you borrowed $200,000, you'll pay $200,000 at the end of the mortgage term.
- You pay interest each month along with a small amount toward the principal. These monthly payments are still lower than what you'd pay with a traditional mortgage, but the end result is that your lump sum payment won't be quite as large as if you just paid interest. You'll also gain a little equity in your home during the balloon mortgage period this way.
Many mortgage types charge a prepayment penalty, or a fee for paying off a large chunk of your principal early. Balloon mortgages don't usually impose prepayment penalties, though, so you can make significant additional payments toward your mortgage to reduce the amount you'll pay at the end, at no extra cost.
You can choose either a fixed-rate or adjustable-rate balloon mortgage. Terms are relatively short, the most common lengths being five and seven years. This means you could own your home outright in a few years rather than in a few decades, as you would with a regular mortgage.
Benefits of balloon mortgages
Balloon mortgages aren't common, but they do offer some benefits if you can get one. These include:
Lower initial monthly payments
You'll pay less each month than if you got a regular mortgage, especially if your balloon mortgage doesn't require any monthly payments toward the principal. If the fear of high payments is keeping you from buying a home, a balloon mortgage could help you afford a home sooner.
Short-term financial flexibility
Balloon mortgages can be a good option if you plan to move soon. If you expect to sell the home before your lump sum payment is due, you can benefit from a good rate and low monthly payments without facing a huge payment in a few years.
They're also a good choice if you expect to receive more money later. If you're confident you'll be coming into a large sum of money before your total payment is due, you might like a balloon mortgage. For example, maybe you earn a huge cash bonus from your job at the end of each calendar year and are sure you can put that money toward your mortgage.
Potential for lower interest rates
Balloon mortgage rates are usually variable and are often lower than rates on other types of mortgages. This can help you if rates start to drop, as it will take your monthly payment down with it.
Risks of balloon mortgages
Balloon mortgages are risky, so it's important to consider them carefully before taking one of these loans out. Risks to think about include:
Large final payment
The downside of low monthly payments is that you have to pay a huge sum at the end of your balloon mortgage term. With a regular mortgage, larger monthly payments help you pay off the total principal over a set number of years. With low balloon mortgage payments, you don't make much progress on your actual loan, and you could pay hundreds of thousands of dollars all at once in a few years.
Refinancing risks
Refinancing your home with a balloon mortgage could be trickier than refinancing with another type of loan. When lenders decide whether to approve your refinance application, they look at how much equity you've built in the home.
With a balloon mortgage, you'll gain little equity — if any — because you aren't paying down the principal. Even if a lender does approve your refinance application, you could get stuck with a high interest rate if you don't have much equity.
Market and interest rate risks
Just as your rate can fall, it can increase, too. If market rates start to rise, it could take your monthly payments out of budget — on top of owing a large lump sum later on. This could even lead to foreclosure if you can't make your payments.
You should also consider home prices. If the market changes and your home's value drops, you may not be able to sell the house and pay off your loan.
Types of balloon mortgages
Balloon mortgages come in several types. These include:
Fixed-rate balloon mortgages
Some balloon mortgages have a fixed interest rate, which means it will stay the same until your balloon payment comes due. This makes for easier budgeting, but the rate is typically higher than on an adjustable-rate loan.
Adjustable-rate balloon mortgages
Many balloon mortgages have an adjustable interest rate. This means the rate changes periodically based on the index it's tied to. This can send your payment up or down as well.
Is a balloon mortgage right for you?
Balloon mortgages can be risky, but they might be a good fit for some borrowers. See below before taking one out:
Considerations before choosing
You'll need to think about your budget and income before getting a balloon mortgage. First, know what you can afford now. If you need the absolute lowest monthly payment, a balloon mortgage may be able to offer it, but you'll also need to have a pulse on your future finances, too. Will you have the funds to cover the balloon payment when it comes due? If you're not sure, a balloon mortgage can be a pretty big risk to take.
Comparing balloon and traditional mortgages
Traditional mortgages are going to come with a lot more stability. With a 30-year mortgage with a fixed rate, for example, you'll have a set rate and payment for the entire loan time, and there are no large lump sums required. This makes it easy to budget for and stay on top of.
That stability comes at a cost, though. You'll usually pay a higher interest rate for longer-term, fixed-rate loans, as it's riskier for the lender to take on. You'll need to consider which to prioritize when choosing what loan to apply for.
Financial goals and risk tolerance
Ultimately, you'll need to think about how much risk you're willing to take on with your mortgage. Is a lower payment worth it?
Your financial goals should play in, too. For instance, if you need to free up cash now for medical expenses or something else, a lower monthly payment might be the only way.
How to qualify for a balloon mortgages
Balloon mortgages aren't widely offered, and every lender that does will have its own qualifying requirements you'll need to meet. With that said, you can generally expect to do the following when qualifying for a balloon mortgage:
Meet a minimum credit score
Credit score requirements will vary based on your lender and loan amount. You will typically need a higher credit score on these loans compared to other options, as they're inherently risky. The lender will want to see that you know how to effectively manage your debts (and a high credit score indicates that).
Bring a large down payment
You will likely need a large down payment, too — potentially 20% or more. Keep in mind that a larger down payment means you'll need to borrow less, so this could reduce the risk the loan comes with.
Have your income and employment verified
Your lender needs to see that you're going to have the income necessary to make your payments — the monthly ones now and the balloon one later on. For this reason, it will evaluate your employment and income history and verify your job with your employer.
FAQs on balloon mortgages
A balloon mortgage is a type of loan that requires a large payment at the end of the term after making lower monthly payments.
When the balloon payment comes due, you must pay off the remaining balance in a lump sum or refinance the mortgage into a new loan.
Balloon mortgages can be beneficial for those who expect to sell or refinance before the balloon payment is due.
Yes, refinancing is an option to manage the large final payment of a balloon mortgage.
