How does a balloon mortgage work?

A balloon mortgage is characterized by its structure of low initial payments that ultimately lead to a significantly larger final payment at the end of the loan's term. This type of mortgage is designed in such a way that the borrower pays interest and some principal over a set period, which can be shorter than the full duration of the loan. At the end of this period, the remaining balance—often much larger due to the low initial payments—becomes due all at once.

The appeal of a balloon mortgage often lies in the lower monthly payments at the outset, which can make it more manageable for borrowers, especially in the early stages of the loan. However, borrowers need to be prepared for the final large payment, as it can come as a shock if they are not financially prepared for this balloon payment. This option is commonly used in situations where borrowers expect to refinance or sell before the balloon payment is due, allowing them to avoid the consequences of the larger payment.

Other options present different types of mortgage structures or features that do not pertain to how a balloon mortgage operates. For instance, equal monthly payments describe an amortized mortgage, automatic conversion of a balloon mortgage to a fixed-rate mortgage at maturity is not a standard feature, and variable interest rates pert