Mortgages typically amortize over time through fixed value installment payments. However, there's a type of mortgage that doesn't: the Balloon Mortgage.
It's called this way because, with it, the borrower sets a time period where he'll pay fixed value installments and, after that, he is obligated to pay the remaining balance of the loan at once. So, as you can visualize, the name balloon mortgage comes both from the shape of the balloon, going from narrow to wide - just like the payments - as well as the act of popping the balloon with one spike/payment.
Balloon Mortgage history:
In the 1920’s most balloon loans were interest-only; the borrower paid interest but no principal. When it reached maturity - usually 5 to 10 years - the “balloon” that had to be repaid was equal to the original loan amount. It was a risky situation, usually endured when the borrower had confidence his/her financial capacity was going to improve in the near future.
The Balloon Loans offered today, in contrast, calculate payments on a 30-year amortization schedule, so there is some principal reduction.
Comparing a Balloon Mortgage to an Adjustable Rate Mortgage (ARM):
It is useful to compare five and seven-year balloon mortgages with adjustable rate mortgages that have the same initial rate periods. They are similar in offering a rate in the early years below that available on a Fixed Rate Mortgage, and both carry a risk of higher rates later on. However, there are some important differences.
Real estate advice:
Hey, that was a hard one, huh? Don’t worry; we have more accessible terms in our Real Estate Glossary for you to unwind.
But the best way to really unwind is to find a real estate agent and let our real estate agents do all the heavy lifting for you!