Interest Only Mortgage versus Balloon Notes

Author: Tony Robinson

You would think the interest only mortgage and the balloon have nothing in common, but they do; they're closer than the FRM and the ARM in terms of comparative benefits. To fully appreciate the balloon note option, since for many years it's taken the brunt of the ""bad product"" review; let's compare it to the interest only mortgage.

The old balloon note, long the product to be avoided, has suddenly become a better friend, even to the more reserved bank mortgage officers. In utilizing the balloon note option, a borrower makes amortized principal and interest payments on the note, as if it were a 30 year note; the catch: if it's a 5 year balloon, the entire balance of the unpaid principal is due at the end of five years, if it's a 10 year balloon, then the entire unpaid balance is due at the end of 10 years. The unsavory aspect of these types of notes has always been the huge payment that was due at the end of a specified amount of time. If the buyer isn't able to find financing at the end of the 5 or 10 year term, or if the property has dropped in value, it's a great way to be bankrupt, or have the property foreclosed on. If you intend to sell your home within a 5 year period, the balloon note option is an excellent alternative that offers a lower monthly payment. But, suppose you don't sell the home? Well you either must come up with the balance of the note, or find an alternative mortgage product. The biggest problem here occurs as you try to deal with the variables in the situation, when the balloon note matures.

When the note matures, if the interest rates are high, or if the real estate market is experiencing a slump, you may be forced to accept a higher interest rate, or produce a very big down payment with a new note. Either solution means that the conditions aren't favorable for the homeowner. But is this so very different from the interest only mortgages?

The interest only mortgages are interest only for a specific term of time; then the principal and interest become due on the note, at a much higher monthly rate. The only difference here is that the lending institution is locked into a 20 or 30 year note. But the borrower is no better off, if he or she cannot afford the payments at the higher level, there still exists a greater potential for bankruptcy or foreclosure.

Thanks to the booming real estate market, and the expansion of the mortgage product market, the increase in purchasing power has enabled many prospective homeowners to actually make a dream a reality. However at some point, the market will cease to boom, and the mortgage market will cease to expand. Will the consumer that purchased the interest only mortgage or the balloon note, be able to afford the consequences, should the home suddenly not be worth the original loan amount? Let's hope for the sake of the unwary homeowner, this is a situation we do not soon encounter. And, for the most part, I don't believe we will. Thanks to the natural disasters along the gulf coast, and the continued demand for real estate, building materials, and existing housing, the prices we're currently experiencing, along with the growth we've seen for the past couple of years, should continue.

There are other, more stable loan products available, but these products don't provide the kind of flexibility for the mortgage lender or the borrower, that the interest only mortgages and balloon notes do. They also don't pose the risk these two loans. The interest rates, however, are very competitive on the interest only and balloon, and I don't' look for the general public to decide in favor of safety over savings. After all, nothing ventured, nothing gained.

Now, you see the old balloon note looks a little sharper than he did before the interest only mortgage moved in. At least with the balloon note a part of the monies paid each month are applied to the principal balance. With the interest only mortgage, all of the payment monies are applied to the interest, so at the end of the interest only term, you still owe as much principal as you did in the beginning. It would seem to me, it's six of one, half a dozen of the other. The borrower really isn't making any progress, either way.

About the author: Tony Robinson is a Real Estate Investor, Webmaster and International Author. Visit http://www.ezy-mortgage.com/ for his tips on mortgages.