When it comes to mortgage loans, there are so many different products that a borrower must be vigilant in learning all the terms in order to avoid getting trapped in a loan not suitable for them.  Some less than scrupulous lenders will go to great lengths to secure a mortgage loan with a borrower that isn’t fully explained in detail. They do this in hopes that the borrower will not realize the true gist of the loan until the papers have already been signed.  Although these types of lenders are in the vast minority they do exist, so it is imperative for borrowers to read all the documents closely and ask as many questions as they need to until they understand the terms of the loan inside and out.

There are different types of hybrid mortgage loans, but the essential concept of a hybrid mortgage loan is that there is a balloon payment involved.  Sure, “balloon payment” sounds reasonable enough…after all, how bad could something be that is named after something so fun? The truth of the matter is that a balloon payment is a rather effective way of forcing many borrowers to refinance mortgages, oftentimes at higher interest rates.

A balloon payment means that at some predetermined point in the mortgage the entire remaining balance of the loan will be due in full.  The predetermined point is not at the end of the loan either, but rather it can be as early as seven years or later.  So although the loan is amortized over a long term, perhaps fifteen or thirty years, the sum of the balance will come due before the full term of the loan.  The borrower will make payments as though the loan was due in fifteen or thirty years, but then at the predetermined time the loan either needs to be paid off or refinanced. 

Ideally, a borrower should be fully aware that the loan will come due in full earlier than the amortized period and be prepared to react accordingly.  Imagine the panic for a borrower, however, if they are unclear regarding the terms of the loan and suddenly realize their entire balance is coming due twenty years before they thought it would be.

Why do lenders offer these sorts of loans? For some borrowers, a balloon payment can be a good idea in theory if they know they will not be in the home for very long.  Some lenders will offer balloon payment loans with attractive interest rates to lure borrowers in.  Other times, balloon payment loans are offered by lending institutions to decrease business for a certain product that they do not necessarily want to handle.  Some credit unions, for example, offer a balloon payment loan with very high interest rates for investment properties.  Not many of the customers even bother applying for this sort of loan through the credit union once the terms are explained, but the credit union can at least claim that they do offer loans for investment properties in case anyone asks. 

The danger in taking on a balloon payment is that borrowers never really know for sure what the future will hold.  Suppose a family decides on a balloon payment because they anticipate staying in a home for no more than three years, but then the family falls in love with the home or maybe is offered a great job in the area and they decide to not move after all.  If interest rates have risen significantly from when the loan was originally written then the family is in the position to have to refinance the loan at a higher interest rate unless they have the means to pay off the balance of the loan when it comes due.  Not many families have that sort of cash sitting in the bank.

It is best to stay away from any sort of mortgage loan which is written based on the intent to refinance or move within a specific amount of years.  Life is predictably unpredictable, and guessing where you will be five or seven years from now can be a tricky game.  Try to avoid taking on a balloon payment if at all possible, and be sure to review every single piece of documentation handed to you by your lender to make sure you aren’t being given this sort of loan without your knowledge. 

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