The refinance boom of the early 2000′s saw the rise of a number of non-conventional mortgage options for homeowners. For most borrowers these mortgages are not the best option. However, depending on your situation, you may benefit from one of these non-conventional loans. One of the simplest, but most often misunderstood is the balloon mortgage.

Traditional Mortgage

It’s best to understand a balloon mortgage in comparison to a traditional mortgage. A traditional, 30-year fixed mortgage is structured in a way that at the end of the 30-year term, the loan will be completely paid off. A percentage of each payment you make on such a loan goes to interest and a percentage goes toward the principal.  That’s pretty simple to understand and is the most popular mortgage type because of its stability and simplicity.

Balloon Mortgage

The balloon mortgage is very similar except for a few key differences. First of all, you pay a smaller payment each month than you would on an equivalent term conventional loan. That seems like a good thing and is what entices many borrowers who take on this loan to do so. To understand it completely we have to ask, “Why would the lender let you pay a smaller payment on such a loan?” Well, it’s because they get it all back in the end, which brings us to the second difference between the two mortgage types.

Although you make a smaller payment each month on a balloon mortgage, that extra amount that you’re not paying all comes due in one single month at the very end of the term. What does that mean? Well, let me lay out an example.

A Balloon Example

Let’s say you get a balloon mortgage and your monthly payment is $1200, however, because it’s a balloon that monthly payment of $1200 will not pay off the loan in 30 years. So, if you managed to get a 30-year balloon, you pay your $1200 per month for 359 months. That very last month, month #360, the entire loan becomes due. In many cases that means you have to come up with $10-, 20-, $30 thousand dollars or more for that final payment. So now you’re wondering why on earth anyone would take a balloon mortgage if they have to make a big lump sum payment at the end, right?

What Good is a Balloon Mortgage?

Although it does seem crazy at first glance that anyone would want to take on a loan that has a final payment in the tens of thousands of dollars, it does make sense if you plan on selling the home before the end of 30 years for example and you would prefer to have more cash in your pocket each month than build equity in the home. Then, when you sell the home you just pay off the mortgage like you normally would (assuming you have the equity required).

So, in practice, a balloon mortgage is very much like an interest-only loan and is geared toward freeing up monthly cash flow rather than building equity in the home. It’s certainly not the best loan for everyone, nor, perhaps for most people, but it is useful under the right circumstances for the right people.