Balloon Payment Mortgage
The payment calculation of a balloon mortgage is identical to a fixed-rate mortgage, usually a 30-year Fixed Rate Mortgage. However, this is all they have in common. If a conventional Fixed Rate Mortgage is expected to be repaid in 30 years, the completely amortizing final payment on a balloon mortgage is due at the end of the 5th or 7th (depending on the contract) year. For 5 (7) years your monthly payments are equal to those of a 30-year Fixed Rate Mortgage, which usually means lower interest rate, a stable predictable amount to pay, no fuss about the market changes in interest rates, the balance of your mortgage is gradually decreasing. This heaven ends when the payment day comes. You have to pay off the 25-year-big remains of your debt in one go. Here I want to note, that the payments you have been making for 5 (7) years have not decreased your balance significantly, as in any Fixed Rate Mortgage’s early years the proportion of money paid towards the interest is a lot higher than the amount paid towards the principal. Now, how good or bad is it?
It can be pretty good, actually, if you are in a situation for which a balloon mortgage can be recommended: you were not planning to own the property longer than 5 (7) years and you stuck to the plan.
In all other “inadvisable” situations you do have to either pay off somehow or refinance. Leaving the pay off option to your personal creativity, I will say a few words about the refinancing. You can refinance with the same lender or you can shop for a better alternative available on the market at the time of refinancing. There is quite a chance than a lot of other lenders will be able to offer you more favorable conditions, than your current lender. In fact, current lenders can become rather greedy when people make a mistake and add an obligatory conversion (refinancing with the same lender) to their contract. Some people say that having this option on paper makes them feel more secure, but this feeling is very much deceiving. The problem is that the contract usually brings a lot of obligations on the borrower, but quite few of them on the lender. In fact, the lender can refuse to convert your mortgage if you were late with just one payment during the last 12 months or if your credit score has deteriorated in any other way, i.e. you must still be able to qualify for the reset. These requirements are practically the same as for a new mortgage with a different lender. Unlike your current lender, however, a new lender will be interested to attract you as a new customer and offer you a lower interest rate. The current lender would not bother to compete: if you signed the conversion option on origination, you are his anyway and he can treat you as he pleases. Unlike an Adjustable Rate Mortgage, a balloon mortgage conversion carries no caps, the only limitation is the lender’s obligation to refinance at the rate the lender is charging in 5 years after the balloon mortgage origination; so the new rate can be reset to literally any value and involve certain conversion costs, too. Any attempts to free yourself from this deal may result in harming your credit score, and you want it really bad to look really good in front of another lender to be able to get a better refinancing deal.
The best way to avoid the entire unpleasantness of refinancing is, of course, not to bring the whole affair to the stage of refinancing at all. Balloon mortgages are efficient only for a short stay in a home; do not use a balloon mortgage for a long-term commitment! There are enough a lot more sensible options on the market for this purpose.
