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Any money that has been borrowed from a home equity loan or a home equity line of credit and remains unpaid at the end of the loan term is a called a balloon payment. This balloon payment is a large lump sum of money that is due when a home equity loan expires. A balloon payment is a risky situation and should be avoided.
Both home equity lines of credit and home equity loans can result in balloon payments.
You take out a home equity line of credit and withdraw your limit of $20,000. You make only interest payments for the life of the line of credit and then you are forced to come up with $20,000.
In a home equity loan, your lender may offer you a lower interest rate if you agree to a balloon payment at the end of the loan term. The lender can offer this lower rate because the interest paid on the large unpaid balloon balance will recover many dollars for the lender. The lender also benefits because without the lower interest rate bringing down your monthly payments, you could not afford to take out the loan. The lower monthly payments make the loan affordable to you - you have easy, manageable payments but at the end of the loan term you are faced with coming up with a large sum of money.
A lump sum balloon payment can only be paid by coming up with a large sum of money, refinancing the balloon amount or taking out another loan, or by selling your home.
Lets review these options.
If you are taking out a home equity loan this means you need cash. In most situations, it is very unlikely that a few years down the road you will somehow 'come up with' many thousands of dollars to pay off your balloon payment.
Refinancing your home equity loan or taking out another loan is both risky and expensive. You cannot predict what the interest rate will be for your new loan since it is many years in the future. Refinancing the balloon payment means you will paying interest on the balloon amount over the life of two loans and you may be charged more fees.
Being forced to sell your home at some point in the future is very risky as you do not know what your house will be worth. If the housing market shifts against your favor and your home falls in value but you are forced to sell, you could lose thousands on your home and you may not even have enough money from the sale to make your balloon payment.
If you need a balloon payment, this may be a sign that you cannot afford the home equity loan. Ask your lender if the loan you are being offered has a balloon payment or if it can create one. A balloon payment is a risky option that should be avoided.
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