Definition
A mortgage that terminates before the principal of the loan is completely paid off is called a balloon mortgage. The balance that must be paid at the end of this term is referred to as the balloon portion of this loan. This type of mortgage can carry a fixed or floating interest rate.
The annual percentage rate, or APR, on a balloon mortgage is usually lower than more conventional loans such as fixed rate or adjustable rate mortgages. This is true because the term on a balloon mortgage is in the range of 5 to 7 years. The shorter term of the loan allows the lending institution to better manage the risk of rising rates, and pass the benefit of this lower risk on to the borrower in the form of more attractive interest rates.
Explanation
The lower interest rates found on a balloon mortgage is advantageous to homeowners that are certain they will be moving from their home before the term of the balloon has expired. However, if the homeowner decides to keep the property, they will have to find a new mortgage to replace the balloon that has expired.
Some balloon mortgages carry what is referred to as a reset option, which allows the borrower to assume a conventional loan (fully amortizing) at the prevailing market interest rates.
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