Balloon payments and how to avoid them

When purchasing a home, you can choose a short-term mortgage loan to cover the financing. These loans usually have a term of 5 to 10 years. These loans are great if you have the cash to pay off the big expense quickly, and you can save a lot of money in the long run by not paying much interest. But if something drastically changes your financial standing in a negative way, the loan can become a gigantic obstacle. This is called a balloon payment, and we will go over it in more detail and how to avoid it.

Balloon Mortgages

Balloon mortgages are created when a short-term mortgage is calculated like a 15 to 30-year term loan. This gives the borrower lower monthly payments but also creates a large lump-sum at the end of the loan term, 5 to 10 years later. Hence, the balloon payment. All of the previously unpaid principal and interest are due, leading to a massive single payment for the borrower. If the borrower is not able to pay it off, he or she will have to default on the loan. This can lead to a foreclosure of the property.

Potential Foreclosure Loan Options

If you have this kind of loan and are unable to pay when it’s due, there are options out there. One possibility is to refinance the loan. You must refinance well in advance of the payment due date in order to ensure that you have the time to qualify and close the refinance. If you successfully acquire the refinance, you can kill two birds with one stone by paying the balloon mortgage off and getting a new loan with terms more suitable to you.

Loan Modification or Extension

Another option open to you is a modification or extension of the short-term loan that you currently have.  Change it into a full 15 to 30-year fully amortized mortgage term. Not only will you have more affordable payments, you will have lower interest rates as well, if your prior interest rate is higher than current market standards. This lowers your payments further and can lead to paying off your mortgage quicker. Also, check out our blog to see where we believe interest rates are heading.

Home Equity Line of Credit

Lastly, if you have built up a large amount of equity in your home, you could use it to acquire an equity line-of-credit. This gives you instant access to a large lump sum of cash to use to pay off the balloon payment.

In conclusion, be honest with your mortgage lender and see which of these options is in your best interest. Be aware of when payment is due and if you cannot pay if off, research other options months in advance. Get multiple quotes from various lenders to ensure that you get the best possible terms you can. Magilla is an easy way to do so as we help provide a complete term selection after you sign up.