Balloon mortgage

A home loan with relatively small payments for a few years followed by one large lump-sum payment of the remaining balance.

What it means

A balloon mortgage sets payments as if the loan ran over a long period, often 30 years, but the loan actually comes due after a short term, such as 5 or 7 years. At that point the remaining balance, the balloon, must be paid in full.

Most borrowers plan to cover the balloon by selling the home or refinancing. That plan can fail if home values drop, rates rise or the borrower’s credit or income weakens. Balloon loans are uncommon for typical U.S. homebuyers today and tend to suit short-term owners, some investors and certain seller-financed deals.

Example

For example, a $200,000 loan at an illustrative 6% amortized over 30 years but due in 7 years carries payments of about $1,199.10 a month. When the 7 years end, about $179,279 is still owed and must be paid at once.

How it’s used

Short-term ownership or investment properties
Seller financing arrangements
Some commercial and construction lending

Strengths and weaknesses

Strengths

Lower payments than a short fully amortized loan
Can bridge a short holding period
May be available when other financing is not

Weaknesses

Large lump sum due at the end
Risk of being unable to refinance or sell in time
Little principal is paid off before the balloon

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.