Balloon Loan

July 30, 2009

A mortgage refers to the transfer of the interest in a property to a lender. It is most commonly a loan of money and is offered as security to the lender when a debt is in place, but the mortgage in itself does not count as a debt. The idea of a mortgage is that the owner transfers this interest to the lender, on a particular condition, which is that the interest will be given back to the owner once he meets the conditions of the mortgage satisfactorily. Essentially, when one lends money to a borrower, a mortgage is that lender’s security that the loan will be paid back in full.



A balloon loan is a kind of mortgage that is more short-term than the usual mortgage we find. It is somewhat similar to a fixed rate mortgage, because it shares some features with it. One of these is that a balloon loan allows the borrower to have a level payment over the duration of the terms of the loan. But balloon loans are different from fixed rate mortgages in the sense that they don’t increase for the duration of the original term.

Most borrowers that obtain mortgages manage to obtain loans that they can fully repay after a particular period of time. This period of time is called the loan term. Most types of mortgages have a defined loan term, but this is not the case with balloon loans, which have no defined loan term. This is because normally, one who takes out a balloon loan cannot, through the monthly payments, sufficiently repay the loan. Thereby, the borrower will eventually need to make payment as a lump sum, which pays most of the principal, once the loan term is over.


The fact that a lump sum payment such as this needs to be made once a short loan term is over can be seen as quite a disadvantage of balloon loans. However, it still carries some important advantages. The most appealing one is that most balloon loans have very low interest rates, so that the borrower can earn more money for the duration of the loan term. The cash earned can be used in any way the borrower wishes, and can therefore even be invested so that more money may be earned, which can then earn the lump sum needed to repay the balloon loan.



Balloons loans that can’t be paid off at once can result in property and homes being lost. Most borrowers manage to prevent such a situation by refinancing the balloon loan’s outstanding payments into another finance line such as a home equity loan. On rare occasions, high rates of interest or credit rates dropping can force people to sell their property or home to repay the balloon loan if it cannot be refinanced as such. It is therefore important to think very carefully before obtaining a balloon loan or any loan that comes with balloon features. As long as thoughtful planning has gone into the repayment scheme, there should be no problem with balloon loans as a short term mortgage.

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Written by Uncle Sam · Filed Under Mortgage and Loan 

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