Balloon payment mortgage


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. A balloon payment mortgage may have a fixed
or a floating interest rate. The most common way of describing a balloon
loan uses the terminology X due in Y, where X is the number of years over which the loan
is amortized, and Y is the year in which the principal balance is due. 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. A related piece of jargon is bullet payment. When a large debt has to be repaid entirely
in one big payment it can be financially crippling, making it a metaphorical bullet to the head
of a company which does not have the cash on hand. With a bullet loan, a bullet payment is paid
back when the loan comes to its contractual maturity—e.g., reaches the deadline set
to repayment at the time the loan was granted—representing the full loan amount. Periodic interest payments are generally made
throughout the life of the loan. Amortization
The typical arrangement for repaying a residential loan is called amortizing payment or amortization. With amortization, portions of the principal
are periodically being repaid until the loan matures. With full amortization, the amortization schedule
has been set so that the last periodical payment comprises the final portion of principal still
due. With partial amortization, a balloon payment
will still be required at maturity, covering the part of the loan amount still outstanding. This approach is very common in automotive
financing where the balloon payment is often calculated with respect to the value of the
vehicle at the end of the financing term—so the borrower can return the vehicle in lieu
of making the balloon payment. Prevalence
Balloon payments or bullet payments are common for certain types of debt. Most bonds, for example, are non-amortizing
instruments where the coupon payments cover interest only, and the full amount of the
bond’s face value is paid at final maturity. Refinancing risk
Balloon payments introduce a certain amount of risk for the borrower and the lender. In many cases, the intention of the borrower
is to refinance the amount of the balloon payment at the final maturity date. Refinancing risk exists at this point, since
it is possible that at the time of payment, the borrower will not be able to refinance
the loan; the borrower faces the risk of having insufficient liquid funds, and the lender
faces the risk that the payment may be delayed. References See also

Paul Whisler

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