Avoid the bang of a bursting balloon

Sellers who agree to carry back a second mortgage frequently insist on a payoff term of seven years or less. Some sellers want their money—the sooner the better. From your view, a short-term second mortgage usually won't make much sense. The short term sends the monthly payments too high. But here's how to solve this problem. It's called a balloon mortgage.

When you use a balloon mortgage, you make monthly payments and then pay the outstanding balance after maybe five or seven years. Say the sellers have agreed to carry back a five-year second mortgage for $25,000 at 10 percent interest. You want monthly payments as low as you can get them. The sellers want to receive as much money as fast as they can. Here are five possible payback schedules:

  • Fully amortizing. Under this schedule you amortize (pay off completely) the $25,000 second mortgage with 60 equal installments (principal and interest) of $531 per month. The sellers might like this schedule, but you might find it tough to pay $531 a month on top of the payments for your first mortgage. So, a balloon might solve your problem.
  • Partially amortizing (15-year term/5-year balloon). Under this schedule, you pay $268 per month. After five years, you pay the balance of $20,280.
  • Partially amortizing (30-year term/5-year balloon). Under this schedule, you pay $219; then after 60 months, you pay a balloon of $24,100.
  • Interest only. Under this schedule, you do not pay down principal. You pay interest only of $208 for 60 months, then the entire $25,000.
  • No monthly payments. This type of balloon requires no monthly payments. Instead, interest builds and is added to the original balance of $25,000. At the end of five years, the accumulated interest and principal due equals $41,133. Although this type of no-monthly-payments-plan for the second mortgage can increase affordability, few sellers are willing to accept it.

Flexibility reigns. You can tailor a payment schedule to reasonably fit the needs of both you and the sellers. Just one caveat: Be careful! Most buyers pay their balloon balances through a refinance or the sale of their property. If not structured with a pessimistic view of the future, however, balloons hoist up a skull and crossbones flag.

Allow yourself plenty of time (at least five years) and plenty of breathing room. Don't base your plan for repayment of the balloon on wild rates of property appreciation or speculative salary increases. Inflated expectations can create a balloon that bursts.

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Responses

  • ruby longhole
    How to avoid balloon mortgage?
    8 years ago
  • MARIO GOTTLIEB
    How to avoid balloon mortgages?
    7 years ago
  • fnan
    How to prevent balloon real estate?
    7 years ago
  • fernando bruno
    How to avoid balloons from bursting?
    7 years ago

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