Balloon payments can be a nasty surprise for any homeowner that does not fully understand their loan contract. Here are the basics you need to understand about balloon payments and why you should avoid them.

What are Balloon Payments?

A balloon payment is simply a large sum of loan principal due at a certain time. The balloon payment can represent a portion or the entire balance of the loan principal. Balloon mortgages frequently come in the form of interest only loans. These mortgages are attractive because of they are easy to loans to qualify for and have very low monthly payments.

The problem with an interest only mortgage of this type is that the balloon payment is due at the end of the mortgage term. Loans of this type are typically only for seven to ten years. At the end of this time the principal balance is due; if you dont have the cash you will be forced to refinance the loan. Refinancing will cost you lender fees; however, if you are unable to qualify for a new mortgage you could lose your home to foreclosure.

Many homeowners used interest only loans of this type because they could not qualify for a traditional mortgage to purchase their dream home. These homeowners could not qualify for regular financing then, and if their financial pictures have not improved, how can they expect to qualify when the balloon payment is due? These people will lose their dream homes to foreclosure.

The lesson to be learned from these homeowners is simple. Do not purchase more home than you can afford using risky financing. To learn more about borrowing responsibly, register for a free mortgage guidebook.