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A balloon payment mortgage is a
mortgage A mortgage loan or simply mortgage () is a loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. The recipient (i.e., the borrower) incurs a ...
which does not fully
amortize Amortization (or amortisation; ) is paying off an amount owed over time by making planned, incremental payments of principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academi ...
over the term of the
note Note, notes, or NOTE may refer to: Music and entertainment * Musical note In music Music is the of arranging s in time through the of melody, harmony, rhythm, and timbre. It is one of the aspects of all human societies. General includ ...
, thus leaving a balance due at maturity.Wiedemer, John P, ''Real Estate Finance, 8th Edition'', p 109-110 The final payment is called a ''balloon payment'' because of its large size. Balloon payment mortgages are more common in
commercial real estate Commercial property, also called commercial real estate, investment property or income property, is real estate Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or w ...
than in
residential real estate A residential area is a land used in which houses, housing predominates, as opposed to industrial district, industrial and Commercial Area, commercial areas. Housing may vary significantly between, and through, residential areas. These include ...

residential real estate
.Fabozzi, Frank J. (ed), ''Handbook of Mortgage-Backed Securities, 6th Edition'', p 1125 A balloon payment mortgage may have a fixed or a floating interest rate. The most common way of describing a ''balloon loan'' uses the terminology ''X'' due in ''Y'', where ''X'' is the number of years over which the loan is amortized, and ''Y'' is the year in which the principal balance is due. An example of a balloon payment mortgage is the seven-year
Fannie Mae The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, is a United States government-sponsored enterprise A government-sponsored enterprise (GSE) is a type of financial services corporation created by the United St ...
Balloon, which features monthly payments based on a thirty-year amortization.seven-year Balloon Mortgages At A Glance
(PDF)
In the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...

United States
, the amount of the balloon payment must be stated in the contract if Truth-in-Lending provisions apply to the loan. Because borrowers may not have the resources to make the balloon payment at the end of the loan term, a "two-step" mortgage plan may be used with balloon payment mortgages. Under the two-step plan, sometimes referred to as "reset option," the mortgage note "resets" using current market rates and using a fully amortizing payment schedule. That option is not necessarily automatic and may be available only if the borrower is still the owner/occupant, has no thirty-day late payments in the preceding twelve months, and has no other liens against the property. For balloon payment mortgages without a reset option or if the reset option is not available, the expectation is that either the borrower will have sold the property or refinanced the loan by the end of the loan term. That may mean that there is a
refinancing risk Refinancing risk, in banking and finance, is the possibility that a borrower cannot refinance by borrowing to repay existing debt. Many types of commercial lending incorporate balloon payments at the point of final maturity. Often, the intention o ...
.
Adjustable rate mortgage A variable-rate mortgage, adjustable-rate mortgage (ARM), or tracker mortgage is a mortgage loan A mortgage loan or simply mortgage () is a loan In finance, a loan is the lending of money by one or more individuals, organizations, or oth ...
s 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. Some countries do not allow balloon payment mortgages for residential housing: the lender then ''must'' continue the loan (the reset option is required). For the borrower, therefore, there is no risk that the lender will refuse to refinance or continue the loan. A related piece of jargon is ''bullet payment''. With a ''
bullet loanIn banking and finance, a bullet loan is a loan where a payment of the entire principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academic officer of a university A univers ...
'', a ''bullet payment'' is paid back when the loan comes to its contractual maturity (for example, when it reaches the deadline set to repayment at the time the loan was granted), representing the full loan amount (also called ''principal''). Periodic interest payments are generally made throughout the life of the loan.


Amortization

The typical arrangement for repaying a residential
loan In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money avai ...
is called ''amortizing payment'' or ''
amortization Amortization (or amortisation; ) is paying off an amount owed over time by making planned, incremental payments of principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academ ...
''. With amortization, portions of the principal are periodically being repaid (along with the loan's
interest In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availa ...

interest
payments) until the loan matures. With ''full amortization'', the
amortization schedule An amortization schedule is a table detailing each periodic payment on an amortizing loan (typically a mortgage loan, mortgage), as generated by an amortization calculator. Amortization refers to the process of paying off a debt (often from a loan ...
has been set so that the last periodical payment comprises the final portion of principal still due. With ''partial amortization'', a balloon payment will still be required at maturity, covering the part of the loan amount still outstanding. This approach is very common in automotive financing where the balloon payment is often calculated with respect to the value of the vehicle at the end of the financing term—so the borrower can return the vehicle in lieu of making the balloon payment.


Prevalence

Balloon payments or bullet payments are common for certain types of debt. Most
bond Bond or bonds may refer to: Common meanings * Bond (finance) In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of ...
s, for example, are non-amortizing instruments where the
coupon In marketing, a coupon is a ticket or document that can be redeemed for a financial discounts and allowances, discount or rebate (marketing), rebate when purchasing a product (business), product. Customarily, coupons are issued by manufacturers ...
payments cover interest only, and the full amount of the bond's
face value The face value, sometimes called nominal value, is the value of a coin A coin is a small, flat, (usually, depending on the country or value) round piece of metal A metal (from Ancient Greek, Greek μέταλλον ''métallon'', "mine ...
is paid at final maturity.


Refinancing risk

Balloon payments introduce 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 Refinancing risk, in banking and finance, is the possibility that a borrower cannot refinance by borrowing to repay existing debt. Many types of commercial lending incorporate balloon payments at the point of final maturity. Often, the intention o ...
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.


References

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