What is a Balloon Payment?
“Balloon payment” is one of those terms you may have heard your lender say and didn’t really understand. A balloon payment is easy enough to understand, and so in addition to defining it in this article, we’ll also talk about why you generally won’t have to worry too much about a balloon payment, and when a balloon payment might actually be advantageous to include.
Investopedia defines balloon payment as: “An oversized payment due at the end of a mortgage, commercial loan or other amortized loan. Because the entire loan amount is not amortized over the life of the loan, the remaining balance as a final repayment to the lender.” So a balloon payment is just a term used to describe a final payment on the house that is (usually) much larger than your normal monthly payment. If the loan you’re being offered has a balloon payment, the lender will most likely make sure you’re aware of it, and will explain what it is if you aren’t sure. For the most part, a balloon payment is a bad thing, but you usually won’t have to worry about it even if you have one, and even if you do it can be used to your advantage. Allow me to explain.
Why You Usually Don’t Have to Worry About It
A balloon payment is due at the end of the mortgage term, which usually means 15 to 30 years from now. On average, a borrower will refinance or move every 4-6 years, which means you are virtually guaranteed to not reach the end of the loan term. The disadvantage to this frequent refinancing is that equity takes longer to accrue, but you can refinance once to get out of the balloon payment, and then stick with your new loan that doesn’t have a balloon payment. Also, while balloon payments are usually fairly large, sometimes they are not, especially if you’ve been making more than the minimum payment over the life of the loan, which leads me to my last point.
You Might Be Able to Use the Balloon Payment to Your Advantage
If you’re responsible with money and are good at planning for the future, you might be able to negotiate a balloon payment in order to get a lower minimum monthly payment, which will allow you to pay more principal than the minimum over time. This might be able to save you money over the life of the loan and also bring down the balloon payment to a very do-able level by the time you get to it. If you are wanting to go with a 30-year fixed, this is something that’s at least worth looking into. This can be risky though because your income might not increase as much as you were planning, or other expenses might prevent you from making as much more than the minimum as you planned on. While you might be able to find a way to use a balloon payment to your advantage, it’s usually a better option to go with a VA hybrid ARM or even a 15-year fixed instead of a 30-year.
So, a balloon payment is just a big payment placed at the end of some mortgage loans. You can usually avoid a large balloon payment by just stating that you don’t want one, but this will cause your monthly payment to be higher. You’ll also probably not have to worry about the balloon payment anyway because you’ll refinance before you get there. There are a few ways that can help you use a balloon payment to your advantage, but they aren’t usually as good as what you can find with different loan options so you’ll want to make sure it’s really the best option for you and your family before you decide on one.
Balloon payments are more common on fixed-rate loans than adjustable-rate loans, since ARMs are reamortized every year and fixed-rates are not. If you already have a mortgage and aren’t sure whether you will have a balloon payment at the end, you should call your mortgage company and find out, because you need to either be saving up for that balloon payment or making more than the minimum on your mortgage to cut it down before you get there.