Imagine a balloon—bright, colorful, and generally indicative of celebration. While this visual can bring a sense of joy or nostalgia to just about anyone, it’s important to consider that not all “balloons” carry this positive connotation. Take for example, a balloon payment on a loan. Instead of air or helium expanding and growing the balloon, it’s being inflated by mounting debt. Suddenly this balloon is all but celebratory.
What is a balloon mortgage?
Unlike a traditional mortgage where you make regular payments toward the principal limit and interest on the loan, a balloon mortgage is quite different. With a balloon mortgage, monthly payments typically cover the interest on the loan, but not the principal. As a result, the monthly payments you make are insufficient for completely paying off the loan balance. When the loan becomes due and payable, you are left with a large total balance to pay. This balance can “balloon” to tens of thousands of dollars.
When shopping for a loan or considering tapping into home equity, it’s important to get all the facts up front. While traditional home equity lines of credit (HELOC) loans are among the most popular financial tools, some can be structured with a balloon payment at the end of the loan’s term. This happens when the HELOC is amortized over a longer period than the life of the loan. Thankfully, not all financial solutions are created equal—more on that in a moment!
How exactly do balloon payments work?
While some balloon mortgages come with 5- to 7-year terms, traditional HELOCs generally come with a 10-year term. Either way, the monthly payments are structured similarly to if you were paying off a 30-year term loan. This makes for extremely low monthly payments, which can seem appealing. However, what’s not always obvious is the balloon payment steadily growing in the background. Most balloon loans require one large sum to pay off the remaining balance at the end of the loan term.
For example, suppose you secured a traditional HELOC to borrow $100,000 with a 10-year term at the current market rate of 6.29%. Your monthly payment would amount to $618.32, assuming it included both principal and interest. However, at the end of the loan term, you would owe a balloon payment of $84,943.25.1 That’s nearly 85% of the loan balance to be paid all at once—yikes!
Risk Factors to Consider
Naturally, the example above begs the question, “Can I afford to pay back this large lump sum?” And for anyone considering a balloon loan, it’s important to think about if and how you can make this balloon payment before signing the loan papers. But that’s not the only risk factor to consider. In order to protect yourself from a potentially devastating payment at the end of the loan, here are a few more factors to keep in mind.
Your Financial/Credit Situation
When contemplating a balloon mortgage, you’ll want to seriously consider what would happen should your financial situation change over the duration of the loan. If your financial situation worsens, you may find yourself lacking the funds to pay off the balloon payment at the end of the loan. What’s more, your credit health may subsequently worsen, making it difficult, if not nearly impossible, to refinance your balloon payment into another loan with a favorable interest rate. Many homeowners struggled with this same scenario after the 2008 financial crisis as they were not able to qualify for a loan large enough to cover their balloon payment. Unfortunately, if this happens to you, the consequences could have detrimental repercussions, including foreclosure or a short sale.
Your Retirement Plans
Balloon payments have the ability to stifle the retirement plans of both pre-retirees and retirees alike. For pre-retirees, a large balloon payment may present financial challenges and leave them short on funds. As a result, many end up dipping into their 401(k) funds which is generally not a wise idea. Not only does taking money out of your 401(k) reduce future gains, it also carries consequences should you leave or lose your job. In this situation, the money would need to be repaid very quickly. And, if you can’t repay in time, you’ll owe both taxes on the money taken out and a 10% penalty if you’re under the age of 59½.2
For retirees adjusting to a limited or fixed income, a balloon payment could burn through a large chunk of their total retirement savings. And since the balloon payment is typically paid as a lump-sum, retirees without a “rainy day” fund or “safety net” could very quickly find themselves in financial trouble, like outliving their retirement savings.
An Alternative Solution
If you’re considering a HELOC, it’s important to shop around and do your research on the loan. Fortunately, one HELOC was designed specifically with seniors in mind: HELOC For Seniors®.
The first and only HELOC built for homeowners 62 and over, HELOC For Seniors® gives you the power to access the cash you need with a reduced monthly payment you can afford. While there are interest-only paymentsthroughout the life of the loan, the loan only becomes due when a maturity event occurs, such as when the borrower passes away or moves out of the home (borrowers must still keep with the loan obligations, including property taxes, homeowners insurance, and home maintenance).
But the senior-friendly advantages go beyond affordable payments. For example, unlike traditional HELOCs, HELOC For Seniors® has flexible qualifications, looking beyond your income and taking your home equity and other assets into account. This can make it easier to qualify, even if your income is reduced or fixed.
But HELOCs aren’t the right fit for everyone. There are other senior-oriented options for tapping into home equity, like reverse mortgages.
What is a reverse mortgage and are they all the same?
Reverse mortgages work by allowing older homeowners to tap into their home’s equity while continuing to reside there well into retirement years—without having to make monthly mortgage payments.3
There are different types of reverse mortgages, with Home Equity Conversion Mortgage the most common. HECMs are insured by the Federal Housing Administration (FHA) and were created specifically for homeowners aged 62 and older to convert a portion of their home equity into cash.
Another option is a “jumbo” or proprietary reverse mortgage, like Platinum, which can offer greater flexibility for homeowners. Platinum reverse mortgages go beyond the limits of a HECM and whether you’re looking to maximize your cash today, plan for the future, or leave a legacy, there’s a Platinum option designed to help you reach your goals.
Today’s reverse mortgages of all kinds come with consumer safeguard measures, contrary to the misconceptions and bruised reputation of years ago. These measures include required mortgage counseling, non-recourse loan protection, a financial assessment, and safeguards for eligible non-borrowing spouses.
Unlike a traditional “forward” mortgage, where borrowers are required to begin repaying the loan right away, homeowners do not have to repay reverse mortgage funds3 until a maturity event, such as after the final borrower no longer lives in the home as their primary residence or becomes unable to meet the loan terms. Better yet, unlike a traditional mortgage, with a reverse mortgage there are no monthly mortgage payments required.2 You can pay as little or as much as you want as often as you’d like. If you have an existing mortgage on your home the proceeds are first used to pay off that loan. In fact, many customers refinance from a traditional mortgage to a reverse mortgage, once they realize it’s a better choice for their unique circumstance in the long run.
At Longbridge Financial, we can help you use your hard-earned home equity to address the financial challenges that impact so many Americans who are in, or preparing for, retirement.
Our sole focus is home equity solutions for seniors. We’ll get to know you, your goals, your home, and your finances as we discuss your options. We will help you determine what solution is right for you. Not all lenders make this commitment.
Understand your options and put the power of your home equity to work for you with a senior-focused solution. To learn more and explore the possibilities, contact the Longbridge team today.