What is a 5-Year Balloon Payment?
What are 5-year balloon payments?
When it comes to getting a traditional home loan, most home loans are fully amortized, meaning that each payment a borrower makes goes to paying off both the interest and the principal. At the end of the loan period, the entire loan is paid off.
Payments on 5-Year Balloon Loans
Despite that, some loans, like balloon loans, are not fully amortizing -- meaning that there is still money due at the end of the loan period. One kind of balloon loan, a five-year balloon loan, has a loan life of 5 years. At the end, the borrower must make a large payment (known as a balloon payment) in order to repay the mortgage.
Benefits of 5-Year Balloon Loans
Balloon loans, such as the 5-year balloon loan, have a variety of benefits for borrowers. Primary among these is the fact that they often offer lower interest rates, and are typically much easier to qualify for than traditional, 15 to 30-year fixed rate mortgages.
This can allow younger homebuyers (or those without great credit and a large amount of savings) to buy a larger and nicer home. It can also be a way to invest in a home that you think will significantly increase in value during the next few years. Despite those benefits, balloon loans aren’t without their fair share of risks.
Risks of 5-Year Balloon Loans
The major risk of taking out a five-year balloon loan (or any balloon loan for that matter), is that you’ll likely have to pay out a huge amount of money at the end of the loan. For example, a 5-year, $200,000 balloon loan with a 4.5% interest rate might only have a monthly mortgage payment around $1,000, but, at the end of the five year period, a borrower would likely owe a balloon payment of more than $183,000. And, unless you’re simply rolling in cash, you likely won’t be able to afford the final payment.
For that reason, the vast majority of balloon loan borrowers do not actually intend to pay the balloon payment at the appointed time. Instead, they usually decide to sell the home, refinance it, or convert the balloon mortgage to a traditional fixed-rate or adjustable-rate mortgage. Some balloon mortgages are built with specific conversion options, such as a 5/25 convertible balloon loan or a 7/23 convertible balloon loan. In many cases, you can convert a balloon loan to a 30-year fixed rate loan at the current interest rates, with an additional 0.375% interest increase.