How to advise clients on balloon payment loans

When it comes to mortgages, there are several repayment structures that borrowers can choose from. Each of them has their own benefits and risks. Among these, balloon payments stand out as a less conventional option. It can offer short-term savings but also carry long-term implications.  

In this article, Mortgage Professional America explains everything about balloon payments. We will talk about what they are and how they work, and tackle if balloon payment is a good idea. We will also talk about why some people avoid it. Keep reading to better guide your clients through this mortgage payment type. 

What is a balloon payment on a mortgage? 

A balloon payment is a large, one-time payment made at the end of a loan term. It's usually much bigger than the monthly payments made earlier. In balloon mortgages, this payment repays the loan in full and is typically due after a few years of smaller, fixed payments. 

While these types of loans were more common before the housing crisis in the early 2000s, they are still used in parts of the mortgage market today. For the right borrower, it can offer flexibility and lower initial costs. But it also comes with serious risks, especially if your clients can’t cover the final payment. 

Ending with a final lump-sum payment, a balloon mortgage starts off with fixed payments for a pre-determined period. Since it is much bigger than the initial payments, the one-time payment is called a balloon payment. 

Watch this short clip to learn more about balloon payments: 

By definition, a balloon loan includes a last payment that’s usually at least twice the size of the average monthly mortgage payment. This often adds up to tens of thousands of dollars due at once. 

Balloon payment: Pre housing crash  

Prior to the housing crash in the mid- to late-2000s, balloon loans were once much more common in mortgage lending. At the time, borrowers seeking a more affordable mortgage were drawn to the lower initial payments required by balloon loans. These smaller upfront payments made homeownership seem more accessible. 

A common strategy among homebuyers was to refinance into a new mortgage before the large balloon payment came due. However, when housing values declined, many homeowners found themselves unable to refinance. Those who couldn't make their balloon payments often ended up in mortgage default. 

In response to these issues, laws have since been enacted to limit the use of balloon payments in traditional mortgage lending. While some home loan providers still offer balloon mortgages, they’re now more seen in the following: 

• private lending 
• portfolio lending 
• construction financing 

Are balloon mortgages a good idea? 

Short answer: It depends. Balloon mortgages can be a good idea in specific situations, but they’re not right for everyone. This type of mortgage has low monthly payments at first, followed by one large payment at the end—called a balloon payment. This final payment can be tens or even hundreds of thousands of dollars. 

Balloon mortgages might work well for experienced investors or clients who expect a large sum of money before the loan ends. They can also be useful in short-term financing, like construction or fix-and-flip projects. Because the payments are lower in the beginning, your clients can use that extra cash for other expenses or investments. 

However, there are big risks. If your clients can’t pay the balloon amount or refinance, they could lose the property. Balloon mortgages also have stricter qualification requirements, making it not one hundred percent ideal for homebuyers. 

As a mortgage broker, it’s vital to make sure that your clients have a sound repayment plan before choosing this kind of loan. If they don’t have guaranteed funds or a clear exit strategy, a traditional mortgage is often the safer choice. 

In short, balloon mortgages can work, but only for the right clients with the right financial plan. 

Why do people avoid balloon mortgages? 

Balloon payments come with serious drawbacks and some with major consequences for your clients. Here’s a quick look at some reasons why borrowers might tend to avoid balloon mortgages: 

1. risk of losing the property 
2. possibility of an additional loan 
3. slower equity build-up 
4. stricter qualifications 
5. higher interest rates 

Let’s briefly discuss them one by one: 

1. Risk of losing the property 

The biggest risk with a balloon mortgage is that your clients might lose the property if they don’t have the funds to cover the final payment. If the borrowers can’t make the balloon payment, the bank or mortgage lender might move to foreclose. 

This can damage credit and put long-term financial goals at risk. 

2. Possibility of an additional loan 

If your clients can’t make the final payment, they might need to take out another loan. This creates added pressure and more debt. The terms of the new loan may also be less favorable, especially if the market changes or if their financial profile weakens. 

3. Slower equity build-up 

With balloon loans, amortization is limited. Monthly payments often cover mostly interest and very little principal. If it’s an interest-only loan, none of the principal is paid down. That means your clients build little to no equity. This can make refinancing extra difficult later. A low-equity position might also limit future options. 

4. Stricter qualifications 

Banks, credit unions, and mortgage lenders offering balloon mortgages might require a larger down payment and a higher credit score. This narrows the pool of eligible clients. Some mortgage brokers might find these deals harder to close due to added underwriting conditions and documentation requirements. 

5. Higher interest rates 

Because of the risk, balloon mortgage rates are often higher than those on qualified loans. In many cases, your clients will find better rates with standard products like USDA, VA, or FHA loans. Brokers should compare options carefully to ensure clients aren’t overpaying for short-term savings. 

How does a balloon payment differ from other loans? 

A balloon mortgage differs from other home loans in many ways, not just the lump-sum payment due at the end of the loan term. Here are four ways balloon mortgages differ from other loans:  

1. type of lenders 
2. criteria to qualify  
3. interest rates  
4. amortization  

Here is a closer look at each of the ways a balloon payment differs from other loans: 

1. Type of lenders 

The mortgage providers offering balloon loans are often different from those offering traditional mortgage products. In most qualified mortgages, balloon payments are not allowed under standard rules. Balloon loans are also excluded from loan types considered stable or compliant with federal guidelines. 

As a result, balloon mortgages are usually offered by private lenders and small firms. They might also be available via special-purpose lending such as construction financing. 

2. Criteria to qualify 

Balloon mortgages follow different underwriting and eligibility practices. Mortgage lenders offering these loans usually set their own rules, as balloon loans do not meet the definition of qualified mortgages. 

Most balloon loans and other non-qualified mortgage products often require stricter borrower qualifications. This includes higher credit scores and larger down payments. 

This means that mortgage brokers must prepare their clients for tougher approval standards. You might also need to spend more time reviewing your clients’ finances before submitting an application. 

3. Interest rates 

Interest rates on balloon mortgages are often higher compared to other loan types. Since these loans carry more risk for the mortgage lender, rates reflect that risk level. 

Mortgage brokers should compare rates carefully with standard options. You have to determine whether the short-term savings of a balloon loan outweigh the longer-term costs or refinancing needs for your clients. 

4. Amortization 

Standard loans—like 30-year fixed mortgages—are fully amortizing. This means that each payment includes both interest and principal. Over time, the loan balance goes down until it's paid off. 

On the contrary, balloon mortgages often only cover interest during the early years. Then, your clients would need to make a large, one-time payment to cover the full remaining balance. There’s no gradual shift toward principal repayment, making it harder for clients to build equity or refinance later. 

Knowing the risks and upsides before going for a balloon payment 

As we have seen, there are reasons why a balloon mortgage might be a good idea for your clients. These can offer lower monthly payments at the start, and it might work for short-term property plans. Still, there are also big risks. Your clients could lose the property if they can’t make the final payment. 

This is why it’s important to go over both the pros and cons carefully. Before your clients take on a balloon mortgage, help them understand how it works. Talk through their long-term goals, earnings, and whether they have a plan for the upcoming balloon payment. 

Watch this clip to know more about a balloon mortgage’s pros and cons: 

How should your clients handle a balloon payment? 

When borrowers handle a balloon payment, they’re getting rid of it or extinguishing it. While it can be challenging, they can move from a balloon payment to a more stable loan in several ways. Here are five options available to your clients: 

1. refinance 
2. pay it off 
3. sell the property  
4. pay more initially  
5. negotiate 

Let’s take a closer look at each to give you a better idea of your clients’ options: 

1. Refinance 

Your clients can obtain another loan when the balloon payment is due. This is known as a refinance. The new loan will extend your clients’ repayment period, sometimes by adding another five to seven years. Another option would be to refinance a mortgage loan into a 15- or 30-year mortgage. 

However, to successfully refinance, your clients will have to meet the criteria for the new loan. This means that their income, credit, and assets must be qualified when they make the balloon payment. When refinancing on a long-term loan, your clients could wind up paying much more in interest since they are borrowing for a longer period. 

Additionally, when your clients refinance, they should hope that interest rates are the same or lower compared to when they first borrowed. Otherwise, they might want to go for a traditional amortizing loan, if available. 

2. Pay it off 

While this sounds naïve, your clients might want to simply pay off the home loan when it is due—if cash flow is a non-issue for them. Of course, this isn’t always possible. After all, a lack of money is the reason they borrowed in the first place. Plus, balloon payments can reach tens of thousands of dollars. 

However, if your clients can generate the funds that they need prior to the balloon payment deadline, they would be in a position to pay it off. 

3. Sell the property  

If your clients want to get out of a balloon mortgage, they can sell the property. This option also works with whichever asset they bought with the loan (a vehicle, for instance). In this scenario, if they sell their asset or property, they can use the money to pay off the balloon mortgage in full. 

This is under the assumption that the asset or property will generate enough money to pay the entire loan balance. Unfortunately, this isn’t always the case. For instance, before the housing crisis, many properties were worth considerably less than the homeowners owed. 

4. Pay more initially 

While it isn’t a requirement, your clients might be able to pay some of the debt early on. If they pay more than the interest assessment, it will be applied to the principal balance. 

Your clients will want to confer with the mortgage lender to make sure there are no extra fees or prepayment penalties. 

5. Negotiate  

Finally, your clients can negotiate an extension. Like the refinancing option, an extension in this case would change the terms of the previous loan. But rather than getting a new deal, an extension would simply delay the timing of the balloon payment. 

In other words, your clients will have different obligation dates but will still likely have the same payment terms as before. 

Helping your clients decide on balloon mortgages 

As a mortgage broker, you must guide your clients in choosing the most ideal type of mortgage that fits their needs and preferences. Make sure that they know all their options, like standard fixed-rate loans or government-backed programs. Comparing alternatives will help them avoid problems down the road such as being unable to save for the loan repayment amount. 

If your clients are unsure about balloon payments, suggest speaking directly with the bank or mortgage lender. The property loan provider can explain details like payment terms, fees, and other critical information. Helping your clients fully understand how balloon payments work can prevent issues like missed final payments or being forced to refinance under pressure. 

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