Should I consider a balloon mortgage?

Virtually every mortgage shopper has the same goal: find the best loan for your money. With the most obvious measure being the interest rate, it’s no surprise that the low APRs and reduced monthly payments of a balloon mortgage can be tempting. But, buyer beware.

Like adjustable rate mortgages, or ARMs, balloon mortgages offer fixed payments for a set term, often five to seven years. But whereas an ARM continues after shifting into an adjustable-rate period, balloon mortgages terminate with the borrower on the hook to repay or refinance the remaining balance. The large size of this balance is the “balloon payment” that gives the loan its name.

Balloon mortgages can make sense for anyone certain they’ll sell their home within the 5- or 7-year loan period, since the sale proceeds can pay off the loan balance. But without that certainty, there are significant risks to balloon mortgages.

First, you may not be able to sell your home for the price or timing you need. You could have difficulty finding a buyer, or decreased home values may mean your sale price won’t cover the balloon payment.

Second, you may encounter trouble refinancing. Again, dropping home values could prevent a lender from offering you a sufficient loan. But credit changes also pose a risk. If your credit score drops substantially, it may be hard or even impossible to refinance.

In either case, if you can’t come up with the balloon payment, you could face foreclosure. Some lenders may try to help you move into another loan to avoid this, but there are no guarantees or requirements that they do so.

The initial savings of a balloon mortgage may be worth the risk in a small number of scenarios. But for the majority of homebuyers, the gamble far outweighs the limited upside.