Mortgages containing balloon payment terms work like this: you pay a monthly payment of principal and interest at a slightly lower rate than a non-balloon mortgage in exchange the lender expects you to payoff the loan early in the form of one last “balloon” payment.

Here’s the catch:

The balloon payment is the entire remaining balance of the loan!

The most common form of balloon mortgage today is the 7 year balloon. This means your entire mortgage balance minus the small principal reduction you’d see in 7 seven years comes due at the end.

For most folks, those without $100,000′s laying around, this would mean selling the home or refinancing to pay the balloon.

This is a bad idea if you don’t want to be forced to sell or refinance and in a bad market. It could be financially devastating if you find the mortgage balance at the time of the balloon is more than the home is worth.

If the home is worth less than the mortgage, you’d be forced to bring cash to closing table whether you are refinancing or selling.

You could inadvertently “paint yourself into a corner” where you don’t have the money to pay the balloon AND you don’t have the cash to sell or refinance yourself away from the balloon.

You are stuck between a rock and a hard place.

Yikes!

The small interest rate savings is not worth the risk in my opinion.

Good question!

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