Advantages and Disadvantages of Balloon Mortgages

One of the best ways, to make a financial decision properly and in a well-informed manner is to write down rational pros and cons of the same. So, if you are thinking of opting for balloon mortgages then considering its advantages and disadvantages becomes a vital deciding factor. But before that understanding a balloon mortgage is essential.look...

Balloon Mortgages: A Quick Overview

Conventionally a balloon mortgage loan is defined as a loan which is repaid in installments for a said amount of time, following which by the way of balloon mortgage payment, the entire loan's debt balance is repaid. The first installments, reduce the balance a little bit and the balloon payment, takes off the entire debt. It is said that the most prominent characteristic of this kind of loan is that it does not amortize, that is the debt on the shoulders of the borrower is not cleared off in successive and equal payments, which is known as amortization. Instead a series of payments followed by one gigantic clear off, of the debt is used.

Disbursement of the Loan Principal amount: 100x

Installment #1: 10x

Installment #2: 10x

Installment #3: 10x

Installment #4: 10x

Balloon Payment: 60x

Note that there are two types of balloon mortgages. Firstly, there are some normal mortgages which have balloon payment clause within them and on the other hand, there are some balloon mortgages which are designed to work in accordance with mechanism mentioned above. There are however, some advantages and disadvantages of balloon mortgages.

Advantages of Balloon Mortgages

The following are some of the key advantages of using the balloon mortgages. Take a look.

• The first advantage of using a balloon mortgage is that the liability which the borrower owes gets paid off pretty quickly.
• The second advantage is that there is no hard and fast rule regarding the balloon payment which can be made at any date. This is applicable for common mortgages which have a balloon payment clause in their agreement.
• The third advantage of such a mortgage is that the total interest that you pay in the entire transaction is relatively low.
• It is also quite easy to refinance a balloon mortgage loan with another mortgage, secured loan or even a home equity loan.
• Several of the balloon mortgage loans, which expire by the end of 7-10 years are expanded to become common or regular 15 or 30 year mortgage.

There are several more advantages of balloon loans, such as the houses of such loans are quite easy to sell off at highly competitive and lower rates. Apart from that, these loans also cost much less and a clean and healthy credit report means you have got yourself an excellent interest rate. This loan can come in really handy if you are buying one property and selling off another or you are expecting huge bulk income in short time period. Speedy and bulk repayment is the motto of this loan. Apart from all these merits, there's a cherry on top. Once you have repaid the loan with the balloon payment and if the real estate prices rise even a bit, then you are left with a real estate and its equity, worth a small fortune.

Disadvantages of Balloon Mortgages

There are also some disadvantages of this loan. In fact the short-term feature of this loan leads to quite some risks and problems:

• The first and the most prominent disadvantage of a balloon mortgage is that these loans tend to have very small time period of repayment. As a result it becomes difficult for people to cope up with the balloon payment installments.
• The second disadvantage of the loan is that in cases, where the mortgagee/borrower is unable to pay off the loan or sell of the property, or refinance it, then he is left with no choice but to face foreclosure.
• Thirdly, the chance of defaulting a loan and facing bankruptcy is also possible, which makes the loan a bit of a risky one.
• The worse scenario that can happen is if the borrower pays off the loan or refinances the loan (if he opts to do so), and then the real estate rates fall, then he suffers a substantial loss and is left with an almost worthless real estate.
• If a borrower chooses to convert to a normal mortgage, then he has to face the prospect of facing a much steeper interest rates.
• This one is often viewed to be an advantage but in reality it is a disadvantage in a guise. The balloon mortgage often tends to have a much smaller down payment and well, in simple terms it means that the total principal amount of the loan is quite high. In such a case, the total amount owned is much larger than, in comparison to a normal mortgage.

Now the obvious drawback that exists, in case of default or foreclosure, is that the credit report of the borrower gets affected. Apart from that due to the short time-span, these loan tends to act as double-edged sword with the 'cons' side having much a sharper edge.

The advantages and disadvantages are almost equal in number and also in terms of their severity. Hence, in such a case, it is recommended that you assess the drawbacks and advantages according to your own financial situation. It will give you a much a better and broader picture of the situation.