Balloon loans, the adjustable rate mortgage loans, are one of the better mortgage loans available in the market, which gives the homebuyer the option to refinance the adjustable rate mortgage at the end of 5 years.

Balloon Loan Concept

An excellent option for borrowers who plan to move or refinance in the foreseeable future, balloon loans are a simple instrument for short-term mortgage, which have some features of a fixed rate mortgage and others from a variable rate mortgage both combined to create an excellent product. The word “balloon” implies that a balance at the end of the term due upon maturity must be repaid or refinanced.

In 1920s, most balloon loans were interest-only, where the borrower used to pay only interest and not the principal, while at the end of the term, usually 5 or 10 years, the balloon that had to be repaid would equal to the original loan amount. In sharp contrast, the balloon loans offered today calculate payments as if the loan was going to be paid off completely over 30 years. For example, a $100,000 loan at the interest rate of 6.5% would have a balance remaining of $93,611 at the end of the fifth year.

This type of loan gives you the benefit of paying lower interest rate on balloon loans than 30- and 15- year fixed mortgages, resulting in lower monthly payments, asking for very little capital outlay during the life of the loan. In a balloon loan the borrower has the considerable flexibility to utilize the available capital during the life of the loan, as most of the repayment is deferred until the end of the payment period. However, this carries a risk; you are supposed to repay all your outstanding balance at the end of your loan term. Usually, this means that you are required to refinance your loan or convert the balloon loan to a traditional loan at the current interest rates.

Traditional Loan Alternatives

Alternatively, balloon loans are referred as a 30-year mortgage, which have to be amortized over a 30-year term, and are quite different from 30 year fixed rate mortgage. Balloon loans offer various types of maturities, but most balloons loans that are first mortgages have a term of 5 to 7 years.

Many balloon loans are sold in the secondary market, which are converted into mortgage backed securities and bonds. Normally, the yields on balloon loans track the maturities of other capital market debt instruments, since balloon loans considered as short-term mortgages offer lower interest rates than 30 year fixed mortgages. Investors in the secondary market tend to purchase balloon loans from mortgage lenders and have helped create balloon loans with refinance options at the end of the balloon period. Occasionally, balloon loans allow borrowers to convert the mortgage at the end of the balloon period to a fully amortizing loan based upon the outstanding principal balance and the current interest rates. Balloon loans are popular among financial institutions as an alternative to leasing, especially in states like Texas, which impose a property tax on leased products.

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Mary Wise, a professional consultant with twenty years in the financial field, helps people in the process of securing personal loans, mortgage, refinance or consolidation loans and preventing consumers from falling into the hands of fraudulent lenders.
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