POP! Goes The Balloon Mortgage

dw_rainJust what is a balloon mortgage, and should you be wary of this type of loan?

Remember, oh, about a year ago, when the credit markets went haywire and we learned that millions of Americans had taken out home loans they suddenly couldn't afford? A number of factors played into that perfect storm; one was the popularity of balloon mortgages.

Balloon loans are deceptive. They usually carry a term of five or seven years, but the payments are based on, say, a 30-year repayment schedule. At first payments are modest — as if you had 30 years to repay the loan! But you don't. After five or seven years, you owe the entire balance of the loan.

Let's do the math: If you borrow $100,000 balloon loan for a period of seven years, at 6.0% interest, your monthly payments are about $599. After seven years you would have paid only about $49,700, with $90,225 now due.

Given that most people don't have that kind of cash, they usually plan to refinance before the loan ends — or sell their home. If the value of the home drops (see economic crisis, above), they may not be able to cover the balloon payment before it pops.

Why we like balloons, sort of: They're often a much lower interest rate than a fixed loan. They're also convenient, if you need a short-term loan and you have ESP and know that you can refinance or sell before you owe that ginormous payment.

Why we think they're scary: Scads of research on financial behavior has shown that people tend to fall for the promise of a short-term gain ("Only $600 a month, honey!") and ignore the price they'll pay down the line.

As with any big financial decision, do your homework, consult online calculators, reckon not only your present comfort level, but your long-term peace of mind. Then go with a fixed rate loan, OK?