As the name implies, balloon payments are on mortgages and refer to the lump sum that’s due at the end of the term. These financial tools offer some advantages, like smaller installment payments at the beginning, and are perfect for people who have a stable income.
One of the big advantages and attractions is that these are affordable in the short term, but the long-term costs and risks need to be considered.
What Are Balloon Payments, and How Are They Structured in Canada?
Balloon payments involve a large sum due at the end of the term, and often have minimal payments due at the beginning. These types of loans can be risky for the borrower because of the large sum of money due at the end.
Balloon payments require that you make small payments throughout the term, or in some instances, you can delay making payments altogether. Some of the agreements that you’ll be involved with mean that you only need to pay the interest throughout the payment term. For the most part, those kinds of mortgages have low costs.
That means at the end of each term, the borrower needs to pay off the loan. The term is defined as the amount of time a borrower agrees to the conditions of a mortgage.
There are two different types to choose from:
- Principal and Interest Payments: The borrower pays off small incremental parts of the principal until the term ends. At that point, they must pay off the remaining principal.
- Interest-Only Payments: The borrower makes interest-only payments during the term. At the end of the agreement, the full principal amount is due.
Deciding which one is right for you means examining your finances. Borrowers need to decide how much money they’d rather save at the beginning and how much they need to spend at the end.
How Do Balloon Payments Affect the Overall Cost of a Mortgage in the Canadian Market?
Balloon payments can significantly affect the overall cost of a mortgage in the long run:
- The overall interest rate can be higher with these balloon mortgages because private lenders and others are taking on more risk.
- One of these loans or mortgages allows you to make small payments over several years. However, if property values drop, refinancing options might not be available.
- A balloon payment, generally a large lump sum, needs to be made at the end of the mortgage.
Even though these types of mortgages have terms of five to seven years, the money you’ll need to pay off the loan balloons at the end of your particular amortization schedule.
What Are the Risks and Benefits of Opting for a Balloon Payment Mortgage?
There are advantages and disadvantages to these financial tools.
The Pros
Very few or absolutely no preliminary payments need to be made. When a balloon loan starts, the payments can be either nonexistent or very small. If you’re looking to finance something on a short-term basis, this is a cheap way to invest. Of course, you need to be aware of and able to meet the requirements of the structure.
You only need to pay off a small portion of the principal for most of the loan term.
The Cons
These loans can be harder to manage compared to traditional loans, and that makes for more risk for the borrower. There’s an intense payment schedule involved. Moreover, the low and short-term costs can spell higher costs over the long term. This is especially true with balloon payments that are structured to be interest only.
Like other types of loans, these payments can be refinanced.
Can Balloon Payments Be Refinanced, and What Options Are Available for Borrowers?
Balloon payments can be refinanced, but you’ll need to consider a few different options. One option is taking on a new loan to pay off the final payment that comes due at the end of the original balloon payment loan term.
Of course, if you plan on refinancing, it’s important to get prepared before the initial term is up. Lenders look at the same set of criteria, such as a debt-to-income ratio, your overall financial health, and even your credit score.
Being underwater can make it difficult to get a balloon mortgage. This term comes into play when you owe more money on your property or home than it’s worth.
- One option to refinance is a traditional bank or credit union. A fixed-rate mortgage from one of these institutions will offer a predictable monthly payment schedule. An adjustable-rate mortgage (ARM) can offer a lower interest rate depending on the market.
- Private lenders are another option. This is the preferred method for people with low credit scores, but the interest rates are higher than those of more conventional institutions.
One of the big issues that homeowners need to look at is that the loan principal balance might not be touched at all by the time refinancing comes up. Generally, homeowners with less than 25% in home equity can’t refinance.
Looking to Learn More About Balloon Payments from a Private Lender?
Mortgage Broker Store handles private mortgage-related products, including bad-credit mortgages. One specialty is applications that don’t meet conventional lending requirements. Our team of private lenders, brokers, and licensed mortgage agents can help. We can also help you get a loan to stop a power of sale or foreclosure. Email ron@mortgagebrokerstore.com or call 416-499-2122.
