Balloon Mortgages Lift You Up and Bring You Down
Buying your first house is exciting and stressful. Getting the money to buy the house is not always easy. A house is the largest purchase you make and houses are expensive. As a result, you may have difficulty finding a lender that is willing to loan you that amount of money. I cannot help you save money for a house. But I can explain some information about mortgages that may help you. You may not be aware of the different types of mortgages available to you. Continue reading to find out what you need to know about mortgages, especially balloon mortgages.
What Is A Mortgage?
If this is the first time you have considered buying a home, you probably do not know much about mortgages at all. If you do not mind, I am going to take a step back and give you some basic information about mortgages to ensure you have all the information that you need. The term mortgage is often used to describe the loan you receive to pay for your house. But it is actually the document that you sign when you buy a house giving the lender the right to take your home if you do not repay the loan. A copy of this document is filed with the county as a legal claim against the house, in case it is needed.
Included in the mortgage documents is a promissory note. This is the actual loan document where you agree to pay back the money that the lender has given to you to purchase your house. Included in a mortgage loan is the money for the house, commonly known as principal, interest, taxes, and insurance. Depending on the type of mortgage you have, including balloon mortgages, the percentage of the various parts of the mortgage will vary. However, these are the common parts of most mortgages. Homeowner’s insurance and taxes are almost always included in your mortgage.
How Is A Balloon Mortgage Different?
Balloon mortgages are a little different than your typical mortgage. You should make sure that you completely understand how they work before you seriously consider obtaining one. Balloon Mortgages are usually intended to be a short term solution. They can also be a high-risk mortgage. Usually, the lender gives you a lump sum for the mortgage. Then you either do not make any payments, or you make interest free monthly payments.
Balloon Mortgages can have a fixed interest rate, which means it does not change for the life of the mortgage. They can also have variable interest rates. This means that the interest rate can change throughout the life of the mortgage. There are different ways that the interest can and will change. You should discuss those details with your lender and make sure you understand them before signing any documents. This information is outlined in the document. These loans can be issued for anywhere from 2 to 30 years.
At the end of that term, you must pay the loan in full. During that 2 to 30 year period, you may make low, interest free payments, which reduces the amount you owe at the maturity of the loan. You may also make no payments, which means you owe the full amount. Often times, those who take on a balloon mortgage either refinance to a different type of loan or sell something significant to pay off the loan in time.
Are There Other Types of Mortgages?
There are many different mortgages other than balloon mortgages of which you should be aware. When making a decision about a mortgage, you should have all the information about what is available to you.
There are interest only mortgages. These are exactly what they sound like they are and you only pay the interest on the mortgage. This means that you are not making any payments on the principal of the loan for anywhere from 5 to 10 years. This is the amount of money you borrow to purchase your home. After the interest only period ends, you then begin to pay a higher payment amount which includes principal and interest.
Adjustable rate mortgages are those where the interest rate is variable, or changes, throughout the life of the mortgage. A common adjustable rate mortgage is one where the interest rate remains the same for 5 years and then is changeable for the rest of the life of the mortgage. If you have a 30-year mortgage, that means your interest rate may change for the next 25 years. The interest rate for the first 5 years is usually fairly low and reduces your mortgage payment substantially. However, when it changes, it can go up so high that you may not be able to afford your mortgage payment. This type of mortgage does pose some risk. Many who choose this type of mortgage often do so because they do not have much to put down for a down payment and then they refinance before the interest rate increases.
Another type of mortgage is one that is backed by the Federal Housing Administration (FHA). The backing by the FHA gives insurance to the lender to protect them against you failing to pay your mortgage. These types of loans are good for those who do not have great credit scores or do not have a large amount of money for a down payment. This mortgage has federal government backing and helps you qualify for a mortgage that you would not otherwise be able to obtain. Anyone, first time or repeat homebuyers, can obtain these loans.
Differences Between An ARM and A Balloon Mortgage
There is a very distinct difference between an ARM and a balloon mortgage. I want to highlight that difference to you because it is important for you to understand. When you have an ARM, you have a lower fixed interest rate for a specific period of time, typically five years. Then the interest rate can increase along with the prime interest rate for the rest of the life of your mortgage. You are also paying against the principal with each payment you make. Every mortgage payment pays both interest and principal. Remember, the principal is the actual price of the house. Interest is on top of that. When you pay the principal, you are gaining value in your house.
I will highlight this with numbers. I am completely making up these numbers, but here we go.
The house costs $200,000 and you borrow $200,000. The lender adds $50,000 of interest. When you make your mortgage payment of $1,000, you are paying $500 of interest and $500 of principal. By the end of a year, you have made 12 payments of $500 towards the principal, which is $6,000. Now, the house is valued at $200,000 and you have paid $194,000 of that and you have $6,000 of value in the house.
With a balloon mortgage, you typically make interest only payments for the life of the mortgage. You are not paying down the principal. At the end of the term, you owe the entire principal for the house, which is the actual cost of the house. Typically, when you owe the balloon payment, you have not paid into the value of the house. The value of the house may have gone up but you have not paid into it at all.
What Are The Advantages To A Balloon Mortgage?
Balloon mortgages have one major benefit such as lower interest rates. When you have a low interest rate, you also have a lower payment each month. This is very advantageous for you when obtaining a mortgage. Hopefully, with the money you are saving each money, you put in an account where it can accrue interest so that when the time comes to make that large house payment, you can pay it. This may be a good idea for you if you expect that your income will increase drastically in the coming years. If you also have less than perfect credit, this may be a good option for you. When you make your payments on time, it can increase your credit score.
You are locked in at a set interest rate, so you do not have to worry about the interest rate going up at any point during the length of your mortgage. And you may be able to qualify for a large mortgage with this type of loan than you would with a traditional type of mortgage. You could also consider this type of mortgage if you know that you are going to sell your house before the full, or balloon, payment is due. Planning to sell your house is only a good idea if you can sell the house for more than what you owe and you can make some money on the house. If you are fixing up the house and you know it will be worth more when you plan to sell, this could be a good option for you.
What Are The Disadvantages To A Balloon Mortgage?
There are some disadvantages to balloon mortgages, also. You should be aware of these before you make any decisions about choosing this type of mortgage. This type of mortgage is risky for you. Many people who choose this type of mortgage do so because they are planning to refinance their mortgage. However, you know what they say about the best-laid plans…it may not work out the way you have it planned. Depending on when you refinance, interest rates can increase significantly between the time you obtain the mortgage and when you refinance. This may mean that your refinanced rate is much higher than what you are currently paying.
There is a chance that you may not qualify to refinance. While you plan to improve your financial situation in the years between your original mortgage and a refinanced mortgage, that may not happen. You may lose your job or your credit score may take a nose dive. Anything can really happen. Property values may also go down. Real estate is cyclical and house values can drop. This could impact how much your house is worth and therefore change the value for which you could sell it. It can also impact your ability to refinance your mortgage, or at least impact that amount for which you are able to refinance.
Should I Refinance My Balloon Mortgage?
There are times when you should consider refinancing your mortgage. One of those reasons may be to get yourself out of one of those balloon mortgages. There are some other times when you may want to consider it. Here are some mortgage tips about when refinancing may be a good idea for you.
If interest rates have dropped and you can get a fixed interest rate lower than what you have now, you should consider refinancing. You can save yourself a large amount of money and stress. You can save yourself from a variable rate interest mortgage or balloon mortgages by refinancing. If you would like to increase, or possibly even decrease, the length of time you have to repay your mortgage, you should refinance your mortgage. If you want to consolidate your debt or use the equity in your home for something, such as home repairs, you should consider refinancing your home. This allows you to take a loan from yourself.
When it comes to balloon mortgages or other mortgages where you are able to pay a lower amount upfront but then are faced with a larger payment, you may want to consider refinancing. Not only can refinancing decrease your interest rate and your monthly payment, but it can also allow you to switch to a different mortgage type.
What Should I Do If I Cannot Refinance My Balloon Mortgage?
If you want to refinance your balloon mortgage, you should start that process early. As much as six months before that final balloon payment is due. That should give you enough time to apply, be approved for, and pay off the balloon mortgage. However, things do not always work out as we have them planned. In the case where you cannot get approved for a refinance, you still have another option or two.
You can try to modify or extend your current balloon mortgage. For example, you can ask to modify your balloon mortgage. Make it a fully amortized mortgage with a term of 15 or 30 years. A fully amortized mortgage is one where the cost of the mortgage, plus interest, and often insurance is broken down in monthly payments. If interest rates are lower than your current balloon mortgage, you can also ask your lender for a lower interest rate along with your mortgage modification. This can help to reduce your monthly payments and allow you to pay off your mortgage sooner.
Another option is if you have enough equity in your house, you may be able to get a home equity loan. This gives you enough money to pay off the balloon payment. You build up equity in your house by making monthly payments. So that the amount of the money you owe on your house is less than the value of your house. That might be hard when you have a balloon mortgage. But if you have done a lot of work to your home and significantly increased its value, it could be possible.
How Does My Credit Impact My Ability To Get A Mortgage?
With balloon mortgages and any other type of mortgage, your credit score directly impacts your mortgage interest rate. You should have some understanding of your credit score before you attempt to obtain a mortgage. This can prepare you for where to shop for a mortgage. Getting a mortgage with good credit is always easier. If you have less than perfect credit, you may have to do a little more research about where to find the right mortgage for you.
The three-digit number that is on your credit report is your credit score. Your credit report shows a detailed listing of all of your credit activities. It shows items such as your payment history and how you use your debt. Your credit report gives lenders an idea of the age of your credit which impacts your credit score. Basically, everything, including late or missed payments impacts your credit score. You build your credit over time and it tells lenders your credit worthiness. The better your credit score is means the easier it is for you to get a lower interest mortgage.
Mortgages can be confusing and overwhelming. There are many mortgage options available; you may be able to afford more than you realize. It is important to find out as much information as you can before agreeing to any type of mortgage. If you choose balloon mortgages, make sure you fully understand them so you can make the best choice.
Julia Peoples is a long-time business manager focused on providing decision making assistance to the public. She works with people at key points of their lives who are making important retirement and financial decisions. She has had many articles published that educate the public on sound financial decision making.
Julia writes for those who are working towards financial freedom or a better understanding of how finances work. She has shared her financial insights with individuals on a one on one basis for years.