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Balloon mortgages: loan options for different life situations.



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Balloon programs are short-term loans--typically five, seven, or ten years--that are amortized over 30 years. After the initial term expires, the remainder of the balance is due in one lump sum or "balloon payment." Typically borrowers refinance or sell their property before the loan reaches maturity. In most cases, balloon programs have a refinance or conversion option that will allow the borrower to switch to a fixed rate program after the initial term has expired. For example, a 7/23 loan offers a discounted fixed rate for the first seven years, then the rate adjusts once and stays fixed at that rate for the remaining 23-year term. The new rate is determined just like an ARM rate: it is the value of whatever financial index it is tied to, plus a margin agreed to by the borrower and lender when the loan is granted. These figures will be in the loan disclosures and can be helpful to borrowers who want to predict what rate they can expect to pay after the introductory period, in order to determine whether they can get a better deal by refinancing.

Disadvantages:  Many balloon programs require borrowers to re-qualify if they wish to convert their loans to fixed rate mortgages once the initial term is up. Those who have been late with their mortgage payments, damaged their credit rating, have reduced income or increased debt (raising their debt-to-income ratio), or have property that has declined in value may have difficulty converting or refinancing. If the due date happens to come up during a period of high interest rates, the borrowers could be stuck with an expensive fixed rate.

Advantages: The advantages of balloon mortgages are similar to those of an adjustable rate mortgage (ARM). The initial fixed rate is set lower than that of 30-year fixed rate mortgages, and the many homeowners who sell their homes after a few years don't need to worry about paying, converting, or refinancing the mortgage. Unlike many ARM loan borrowers, balloon mortgage borrowers are generally qualified at the initial rate, so they might be able to buy a more expensive house than they would with a 30-year fixed rate mortgage. If interest rates drop when the loan converts, the borrowers can end up with a nice low-interest fixed-rate mortgage at little or no additional cost.

Because the advantages and disadvantages of balloon mortgages are similar to hybrid ARMs, those shopping for a mortgage would be wise to compare current rates and terms for both kinds of financing and before making a decision. 

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