The balloon mortgage loan is an installment note whose amortization is longer than its term. Simply, the payments are calculated for a long-term period, but the loan’s actual life is relatively short-term—with the “balloon” mortgage balance due at the end of that short term.
The balloon loan used to be one of the chielf alternatives to the fixed-rate program, because it offered lower rates without the increased risk of the ARM loan. With the evolution of the 3/1, 5/1 and other Two-Step ARM programs, the balloon program is regularly ignored by most homebuyers and homeowners. However, it is still widely used for commercial and non-conforming loans.
The most common types of residential balloon mortgage loans are the five-year and seven-year balloons for conforming loan programs. However, 10-year and 15-year balloons are also prevalent among non-conforming programs. The majority of commercial and apartment building loans today are balloon loans.
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The “typical” mortgage, if there is such a thing, is a 30-year loan at a fixed interest rate, with equal payments made monthly. This type of loan offers the security of a fixed payment amount that you can factor into your budget. The amount of the payment is allocated between interest and principal based on the declining balance of the loan; in the earlier years a larger part of the payment goes toward interest. (Your lender might calculate the interest using either the “30/360″ method, in which it is assumed that a year consists of 12 equal 30-day months, or the “actual number of days” method, in which interest is calculated more precisely based on how many days are in each month and exactly when your payment is received.) Some lenders have begun offering 15-year loans. A 15-year loan gives you the benefit of a shorter loan life, meaning you pay significantly less total interest on the loan. Since the loan term is shorter, however, you have to pay more each month–not double the amount of a payment on a 30-year loan, but significantly more, nonetheless.
For example, on a $100,000 loan at 10% interest, your monthly payment would be about $1,075 for a 15-year loan term, compared to $875 for the 30-year loan. However, the $200 difference in the monthly payment saves you over $120,000 in total interest. (These figures do not take into account any payments you would have to make each month to be put into escrow for property taxes and insurance.)