A balloon mortgage is only convenient until you can't make the final payment. When you open a balloon mortgage, you assume that you will have the money to pay it off at the end of the term. This is often dependent on the sale of your property. If you end up in this situation, contact the bank to assess your options
The Balloon Payment
A balloon payment can be a difficult concept to understand. These types of loans are reserved for borrowers with a specific endgame, typically the sale of a property. For example, suppose a real estate investor purchases a home to renovate and lease before ultimately selling the property. The idea is to take a year for renovations and then lease the property for the next four years. If the total project will cost $350,000, it will be onerous to pay in just five years. A $350,000 loan for five years at 4.5 percent will have a monthly payment of $6,525. That same loan for 25 years will cost $1,945 per month, a much more manageable figure. Since the borrower doesn’t need the loan for 25 years, he will get a five-year loan that is repaid as if it were a 25-year loan. After five years, instead of having 20 years left, he will owe the entire balance and outstanding interest of the loan. The final payment expands greatly, hence the term “balloon.”
Contact the Bank
You will likely know well before maturity whether you will have trouble making your balloon payment. Contact the bank as soon as you know it may be an issue. Speak to a loan officer and explain the situation. Perhaps you are not able to sell the property, or a favorable tenant has convinced you to extend the lease. Provide the bank with whatever it needs to get a picture of your financial situation. This can include tax returns, pay stubs, lease agreements and authorization to check your credit. The bank will want to see if it can modify the loan or if it wants to do nothing and demand payment when the loan balloons.
Modify Your Loan
If you are cooperative with the bank, it is likely that it will offer you a modification of some sort. This can be a short-term extension of the loan, typically six months to a year, or it can be a complete restructure of the terms. Often, when a borrower has paid as agreed, but is unable to make the balloon payment, the bank will convert the loan to full amortization. This means it will become a full 25-year loan as opposed to coming due in five years. If, however, your financial situation has deteriorated and the bank demands that you make the final payment, you will have to seek alternate financing or risk losing your property.
Ultimately, if you can’t come to terms with your current lender, you can seek to refinance at another bank. You will have to start from scratch and go through that bank’s application process. If you still have good credit and strong income, it probably won’t be an issue. However, if your situation is not as favorable as it was when you first got the loan, you may have to look to banks that specialize in work-out financing. You may get a reprieve from the balloon payment, but you will also face higher fees and interest rates.