What is a Balloon Mortgage
A balloon mortgage is a type of loan that requires a borrower to fulfill repayment in a lump sum. These types of mortgages are typically issued with a short-term duration. Balloon mortgages may be payment free or they may require interest-only installment payments.
BREAKING DOWN Balloon Mortgage
Balloon mortgages can be relatively high risk products for credit issuers since they rely on a lump sum payment rather than providing steady cash flow over the life of the loan. These types of loans are often used in the construction industry to provide short-term financing for construction projects without collateral. Generally, these loans are often unsecured loans with higher interest rates that are issued to borrowers with relatively higher risks than other types of credit.
Balloon Mortgage Structuring
Balloon mortgages can be structured with varying terms and maturities. Balloon mortgages can have fixed or variable interest rates. Some short-term loans may require the borrower to make the principal and interest repayments at the maturity of the loan with no amortization over the life of the loan. Balloon mortgages can also require interest-only payments which allow borrowers to make a lower monthly payment and then a lump sum repayment of principal at maturity.
Balloon mortgages can be issued for durations ranging from approximately two years to 30 years. Balloon mortgages usually provide an option for early repayment with no penalty.
While these loans do allow for low or no payments throughout the life of the loan they still must be paid off in full at maturity. Borrowers may plan to sell a real estate property when a balloon payment comes due in order to payoff the outstanding balance. Oftentimes, commercial construction borrowers will obtain a take-out loan to cover the costs of a balloon mortgage loan and subsequently gain more favorable lending terms.
Balloon Mortgage Construction Loan
Commercial construction companies often rely on short term balloon mortgages to finance the construction of a real estate property which has no available collateral. In this situation a construction company would obtain a balloon mortgage loan with terms matching their expected timeframe for construction. For example, a company could obtain an 18 month balloon mortgage loan to cover costs on a building product it expects to take 12 to 18 months. If construction goes according to plans and the company finishes the building in 12 months the company can now seek to obtain a new take-out loan to payoff the balloon loan six months early and receive more favorable loan terms with the building as collateral. It may also be able to refinance the balloon loan with a lower interest rate now that the building is complete and can be used as collateral in a secured loan.