Balloon Payment


A balloon payment mortgage is a mortgage which does not fully amortize over the term of the note, thus leaving a balance due at maturity. The final payment is called a balloon payment because of its large size. Balloon payment mortgages are more common in commercial real estate than in residential real estate.

The shorter term of a balloon payment mortgage gives the lender better security against interest rate risk than a 30-year fixed-rate loan, while giving the borrower the security of a fixed payment and possibly a lower interest rate than a 30-year fully-amortizing fixed-rate loan.

An example of a balloon payment mortgage is the 7-year Fannie Mae Balloon, which features monthly payments based on a 30-year amortization.

In the United States, the amount of the balloon payment must be stated in the contract if Truth-in-Lending provisions apply to the loan.

Because borrowers may not have the resources to make the balloon payment at the end of the loan term, a "two-step" mortgage plan may be used with balloon payment mortgages. Under the two-step plan, sometimes referred to as "reset option", the mortgage note "resets" using current market rates and using a fully-amortizing payment schedule. This option is not necessarily automatic, and may only be available if the borrower is still the owner/occupant, has no 30-day late payments in the preceding 12 months, and has no other liens against the property. For balloon payment mortgages without a reset option or where the reset option is not available, the expectation is that either the borrower will have sold the property or refinanced the loan by the end of the loan term. This may mean that there is a refinancing risk.

Adjustable rate mortgages are sometimes confused with balloon payment mortgages. The distinction is that a balloon payment may require refinancing or repayment at the end of the period; some adjustable rate mortgages do not need to be refinanced, and the interest rate is automatically adjusted at the end of the applicable period. Some countries do not allow balloon payment mortgages for residential housing: the lender must continue the loan. To the borrower, therefore, there is no risk that the lender will refuse to refinance or continue the loan.