Real Estate Balloon Payment

A balloon payment is the outstanding balance that must be paid off at the end of the term on a Home Equity Line of Credit. A balloon payment is defined as a “large, lump-sum payment” scheduled at the end of a series of considerably smaller periodic payments.

With a traditional home equity loan, borrowers pay only interest during the initial life span of the loan. Over time the borrow will still pay interest but at the same time more of their monthly payment goes toward chipping away at the principal. At the end of the term they will owe nothing.

Balloon payments are often prepackaged into what are called “two-step mortgages”. In this type of mortgage, the balloon payment is rolled into a new or continuing amortized mortgage at the prevailing market rates.

Balloon payments can occur within a fixed-rate or adjusted-rate mortgage (ARM). Adjustable rate mortgages are sometimes confused with balloon payment mortgages. The distinction is that a balloon payment may require refinancing or repayment at the end of the period; some adjustable rate mortgages do not need to be refinanced, and the interest rate is automatically adjusted at the end of the applicable period.

Are Home Equity Lines of Credit Reduced
Home equity lines of credit are not fully amortized; the principal is not paid off over the life of the loan. These home equity lines of credit are set up for a “balloon payment”. This is when the borrower has been paying only the interest, or some combination of interest and principal, and when the loan term expires the balance is due in full.

Balloon payment example: If you borrow $15,000 and your monthly payments for 10 years have included only interest, you must pay $15,000 at the end of the term. You must be prepared to make this balloon payment by refinancing it with the lender, by obtaining a loan from another lender, by selling your home, or by some other means. If you are unable to make your balloon payment, you could lose your house.

Balloon payments induce a certain amount of risk for the borrower and the lender. In many cases, the intention of the borrower is to refinance the amount of the balloon payment at the final maturity date. Refinancing risk exists at this point, since it is possible that at the time of payment, the borrower will not be able to refinance the loan; the borrower faces the risk of having insufficient liquid funds, and the lender faces the risk that the payment may be delayed.