Balloon Mortgage
A Balloon mortgage is a special type of mortgage. Traditionally, a mortgage loan is repaid through equated monthly installments covering the entire term for which the loan is granted. Such repayment is known as amortization. In case of balloon mortgage loan, such amortization schedule does not clear the entire loan amount. Instead, there is some part of the loan amount that remains outstanding even after the amortization schedule. The borrower repays this outstanding amount through some savings or any anticipated receipts at that point of time.
Mortgage loans are usually taken to purchase a home or any commercial property. The repayment terms are fairly long so that the borrower can repay the amount in smaller installments. These installments may include both interest as well as principal components. These installments are also equal during the amortization term, unless there is any revision in installment due to the interest rates hike.
Adjustable interest rates may result in higher installment or longer repayment period. The installments are paid every month, and are referred to as equated monthly installments, or the EMIs. Any such EMI is determined considering the rate of interest and the term of repayment, apart from the loaned amount of course. Longer the term, lower will be this EMI. Likewise, lower the interest rate lower will be the EMI. Loan amount is also directly proportional to the EMI. Even after tweaking these factors, if the EMI remains a tough proposition, then the lenders suggest mortgage loan products such as balloon mortgages.
The advantage of taking a balloon mortgage is that EMIs are lower. The word balloon refers to the final installment, which may be substantially larger than the EMIs. Like in any other mortgage loan, interest applicable on this mortgage may be calculated on fixed rate, or adjustable rate. Many of balloon mortgage products have what is known as reset option. This option is specially included to enable the borrower to repay the loan when the probability of receiving the amount at the end of mortgage term is uncertain.
In reset option, which is also known as mortgage plan with two-steps, the amortization schedule gets revised after a specific period. At the time of resetting, the EMI is revised upwards, such that the outstanding loan amount is completely recovered, or very little amount remains outstanding at the end of the term. This does seem similar to the revision of EMIs in the case of mortgages carrying adjustable rate of interest.
Advantage of balloon mortgage loan is that it enables borrower to avail larger amount of loan than he or she may be eligible for. Effectively, borrowers may be able to purchase the real estate properties, which otherwise, could be beyond their reach. Mortgage products like balloon mortgage loan make real estate properties, whether they are commercial properties or homes, affordable.
There are tax concessions for interest paid on mortgage loan. These are applicable to balloon mortgage as well. The only major drawback is that the borrower pays interest on the outstanding loan amount, which is invariably higher. But when the amount is finally repaid, the purchasing power of the amount is much lower, because of inflation eroding its value. Likewise, even the excess interest paid is also of much lower value. Because of this, balloon mortgage is still worth it.