A balloon mortgage3 is a loan that is paid as a large single, final payment. Typically, relatively small monthly payments are made, instead of a fixed monthly payment that gradually eliminates the debt2. But those payments will not be sufficient enough to pay off the loan before it comes due. Therefore, a final “balloon” payment needs to be paid at the end of the term, in order to to pay off the remaining loan balance.
The borrower’s monthly payment is calculated using a longer term, usually 30 years, to keep the monthly payment affordable. However, this lower payment means that at the end of the mortgage term, a very large balance remains. It can be zeroed out with a single payment, or the borrower may be able to refinance it.
The advantage of this loan is a lower mortgage rate and payment. However, the risk is that there is no guarantee of being approved for a new loan, nor any way of knowing what interest rates might be at that time. A balloon payment is for honest and qualified borrowers who have a good credit history.
Borrowers interested in a balloon mortgage should also compare it to adjustable rate mortgages4, as it offers a little more protection for a similar interest rate.