A balloon loan is a mortgage that requires a large one-time payment at the end of the loan. In exchange, your payments will likely be lower for many years, until the balloon payment is due. Aside from this repayment obligation, a balloon payment is the same as a standard fixed-rate mortgage.
In general, the balloon payment is over two times the loan's average monthly payment, but it is often tens of thousands of dollars. Most balloon loans require a single large payment that pays the remaining balance.
Effective January 2014, lenders must now comply with new mortgage rules, which were designed to eliminate surprises and debt traps for consumers. Among them is the Qualified Mortgage rule.
A qualified mortgage is designed to make sure you do not take out a loan you cannot afford. When a lender makes a loan that meets qualified mortgage standards, they gain legal protection if you later default, because the loan itself is deemed safe. This means a qualified mortgage cannot have risky features.
Risky features, according to the new mortgage rules, are terms longer than 30 years, interest-only payments or minimum payments that will not keep up with interest.
Balloon payments are generally considered risky, so many balloon loans will not meet qualified mortgage standards. This does not mean a lender will not provide the loan, but you may have greater difficulty qualifying.
There is an exception to this rule. Certain balloon loans may be considered a qualified mortgage if they are originated and held in a portfolio by a small bank or lender in a rural area.
If you are considering a balloon loan, you must think about whether or not you will be able to make the balloon payment or be able to refinance the loan when it is due.