Balloon payment mortgage
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A balloon payment mortgage is a
mortgage A mortgage loan or simply mortgage (), in civil law (legal system), civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners ...
which does not fully amortize over the term of the
note Note, notes, or NOTE may refer to: Music and entertainment * Musical note In music, a note is the representation of a musical sound. Notes can represent the Pitch (music), pitch and Duration (music), duration of a sound in musical notation. A ...
, 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 (buildings or land) intended to generate a Profit (economics), profit, either from capital gains or Renting, rental income. Commercial ...
than in
residential real estate A residential area is a land used in which housing Housing, or more generally, living spaces, refers to the construction and housing authority, assigned usage of houses or buildings individually or collectively, for the purpose of Shelte ...
.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 (GSE) and, since 1968, a publicly traded company. Founded in 1938 during the Great Depression as part of the New ...
Balloon, which features monthly payments based on a thirty-year amortization.seven-year Balloon Mortgages At A Glance
(PDF)
In the United States, the amount of the balloon payment must be stated in the contract if Truth-in-Lending provisions apply to the loan. Most commonly, term lengths are five or seven years. 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
lien A lien ( or ) is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation. The owner of the property, who grants the lien, is referred to as the ''lienee'' and the pers ...
s 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 Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to anoth ...
.
Adjustable rate mortgage A variable-rate mortgage, adjustable-rate mortgage (ARM), or tracker mortgage is a mortgage loan A mortgage loan or simply mortgage (), in civil law (legal system), civil law jurisdicions known also as a hypothec loan, is a loan used either ...
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 loan A bullet is a kinetic projectile A kinetic energy weapon (also known as kinetic weapon, kinetic energy warhead, kinetic warhead, kinetic projectile, kinetic kill vehicle) is a weapon based solely on a projectile's kinetic energy instead of a ...
'', 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, 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 debt and is usually liable to pay interest on that de ...
is called ''amortizing payment'' or '' amortization''. With amortization, portions of the principal are periodically being repaid (along with the loan's
interest In finance and economics, interest is payment from a debtor, borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is ...
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 A mortgage loan or simply mortgage (), in civil law (legal system), civil law jurisdicions known also as a hypothec loan, is a ...
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), a type of debt security * Bail bond, a commercial third-party guarantor of surety bonds in the United States * Chemical bond, the attraction of atoms, ions or molecules to form chemical ...
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'', "min ...
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 Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to anoth ...
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. Because balloon mortgages can carry risk, some lenders may require a minimum 20% down payment from the borrower.


References

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