In today's housing market, there are mortgage lenders for almost anyone in any circumstances. Balloon loans are one type of specialized loan, but they can be very dangerous if loan holders aren't careful.
What Is a Balloon Loan?
Balloon loans don't have anything to do with hot air or traveling around the world in 80 days. However, they can cause your financial future to go up in flames like a Hindenburg balloon if you don't exercise supreme caution.
For a set number of years, the balloon loan has a constant, fixed interest rate. Regular fixed rate mortgages are more middle of the road, but balloon loans carry interest rates as low as adjustable rate mortgages. Balloon loans are even riskier than ARMs, however, because of their length.
It's true that loan holders pay an extremely low fixed rate for a certain length of time, but it usually isn't very long. Most loans have terms of 15 or 30 years, but the typical balloon loan matures in seven to ten years. When the term is up, the loan holder is forced to pay the rest of the loan in full. That means every penny you owe.
Let's say that it's the year 2005 and you find the perfect house. You love it, but can't qualify for a mortgage. You want the house so badly that you scout out a lender to give you a balloon loan for $ 400,000 with a seven-year term. Fast forward to 2012. The term is up, and you've paid $ 50,000 on the loan, leaving $ 350,000 remaining. You now owe $ 350,000 and need to pay the full amount or surrender your home to foreclosure.
Of course everyone who takes out a balloon loan plans to get refinancing before the term of the loan is up, but sometimes it doesn't work out that way. It's also worth noting that we are now seeing record low interest rates, and it's likely that refinancing several years from now will make your rate higher. Are you sure you can afford that?
Trying to play and win at the balloon loan game is taking a gamble with the future. You're betting on low rates several years from now. But do you really want to be stuck in an awful financial situation if you bet wrong?