It sounds a little strange doesn’t it that companies would come up with the name “balloon” to describe a mortgage. However, it makes more sense when you understand what a balloon mortgage is. It allows you to borrow a larger amount, paying only on a percentage of what is borrowed, and then making one “balloon” payment at the end of the term.
There are several risks to using this type of loan because you do need to make sure that upon the date the final balloon payment is due, there are sufficient funds available to do that. Given over a shorter period of time, the balloon mortgage is a quick way of releasing optimal funds. So, in circumstances where money needs to be released on an investment, which can pay off short term, this is ideal.
When It Makes Sense
If you were to invest in a development property and needed more cash in your hand to develop the property, this system of loan does that. You borrow a larger amount and pay back smaller installments.
These easier terms will give you valuable cash, to develop or refurbish the property. It makes sense for property development if there is a certainty that it can be developed and sold on or remortgaged when the balloon payment is due.
Astute property investors can use this system of mortgage to free up cash flow but there are risks.
The Risks Of A Balloon Mortgage
If the property investment turned stale and the property could not be sold at the anticipated profit, there may not be sufficient money in the pot to pay off the balloon payment. Additional financing would be needed to pay this, although no one can anticipate that far in advance how much the lending rate would be. This may be unacceptable and make the balloon mortgage more costly than anticipated.
Is It Risky For The Lender?
It certainly is a risk that lenders have to take into account, although financial institutions find themselves in a win-win situation by encouraging a balloon mortgage. Short term, they are putting money into a state of flux, or borrowed without payment being made short term for the balloon payment.
For example, if the mortgage is for $700,000 and the balloon payment is $300,000, then the bank only get payment on a monthly basis for $400,000. How can this be advantageous? It’s advantageous for the bank because they are betting on a certainty.
The mortgage rate will be set as will the balloon payment and will cost the consumer more than the amount borrowed. If the consumer then has to take out further finance to pay the balloon, the bank gain even more than originally anticipated.
So Is A Balloon Mortgage Worthwhile?
Yes, a balloon mortgage is worthwhile if you know that finance will be readily available on the balloon payment date. That’s where strategy comes into the picture. However, if there is any doubt, then another form of mortgage may be a better option.