Balloon Mortgages

Reducing your monthly payments

A balloon mortgage takes a five- to seven-year term and amortizes it over 30 years, effectively reducing the monthly payment. The downside of this strategy is that when the term comes due, you must pay off the remainder of the balance. For most, that means refinancing the loan, partly defeating the purpose of a 30-year amortization.

Before agreeing to the terms of a balloon mortgage, make sure your lender will provide refinancing at the end of the term without any conditions such as income qualification, etc. If you've made all your payments over the initial term, it's likely you will continue to do so.

Here are some reasons to explore this type of mortgage:

• The interest rate and monthly payments are lower than a traditional fixed 30-year mortgage. For those on a tight budget, this will provide a little flexibility with your spending.
• If you know you'll have the funds in five to seven years to cover the repayment of the balance, you'll save yourself some money.
• If you're confident that interest rates won't move very much during the term, again, the low rate and payment will save you money.
• If you know you're going to be relocating before the end of the term, it also makes sense.
• The payments over the term of the mortgage are constant. At no time over the five to seven year period will the payment amount change.

A common balloon is the 7 / 23 convertible mortgage. This means you pay a fixed rate for seven years based on a 30-year amortization. At the end of the term, you convert to a 23-year fixed term, adjusted to the prevailing rate at the time and amortized over 30 years. It's important to mention that some banks offer 7 / 23 balloon mortgages that convert to ARMs. This isn't a good choice for most people given the current direction of interest rates.

Although you might get a better rate than the traditional 30-year fixed mortgage, in most cases it's questionable whether the positives outweigh the negatives. Most people would be better off locking in their mortgage and working toward paying it off over time. Often, the simplest solution is the best one.