How a balloon mortgage works
A balloon mortgage has payments figured as if the loan ran for a long term, often 30 years, but the loan actually ends much sooner, commonly after 5, 7 or 10 years. At that point everything still owed is due at once: the balloon payment. The monthly payments are the same as a regular loan's, but only part of the principal has been paid when the balloon arrives.
How big is the balloon?
The balloon is the balance left after the regular payments made so far:
B = P(1 + r)k − M × ((1 + r)k − 1) ÷ r
where P is the amount borrowed, r the monthly rate, M the monthly payment and k the number of payments before the balloon. A $320,000 loan at 6.5%, amortized over 30 years with a 7-year balloon, has a payment of $2,022.62 and a balloon of about $289,000: after seven years, only about 10% of the loan has been repaid.
Planning for the balloon
Most borrowers plan to sell or refinance before the balloon comes due. That carries risk: if rates rise or the home's value falls, refinancing can cost more or be unavailable. Extra principal payments shrink the balloon; add them above to see by how much.