A balloon mortgage might sound like a fun name, but it’s a serious financial commitment. Simply put, it’s a home loan wherein you make low or no monthly payments for a short period, typically five to seven years. Then, you’re expected to make a significant lump sum payment, often called the ‘balloon payment’, to settle the remaining balance. Due to its unique structure, this mortgage can be both tempting and treacherous. Let’s dive into its intricacies.

The Mechanics of a Balloon Mortgage
So, how does this peculiar mortgage work? For a set duration, you’ll make minimal payments that could go solely towards interest or might include a portion of the principal, depending on your loan’s terms. At the end of this period, be ready for the balloon payment – a hefty sum that can exceed double your monthly installments. This structure can manifest in a few ways:

Balloon Payment Structure: Your initial monthly payments might mimic those of a 15 or 30-year mortgage, but the full balance becomes due much sooner, say in 5 or 7 years.
Interest-Only Payments: For a while, you only tackle the interest. When this phase concludes, you owe the remaining loan balance.
No Payments: This high-risk version involves no monthly payments for a brief term, but interest keeps accumulating. Once the term concludes, you owe both the interest and the principal.
The Allure and Concerns of Balloon Mortgages
On the surface, balloon mortgages seem attractive. They promise low initial outlays, the opportunity to buy a home sooner, and the flexibility to focus on other financial objectives. Moreover, they typically lack a prepayment penalty, allowing borrowers to settle their debt earlier without extra fees. However, they come with significant caveats. The looming balloon payment can jeopardize your home ownership if you can’t meet the commitment, leading to foreclosure. Plus, these mortgages are elusive, often bearing higher interest rates than conventional loans, and refinancing can be challenging.

Making Informed Decisions on Balloon Mortgages
So, when does a balloon mortgage make sense? It’s a viable choice for property flippers, intending to sell before the balloon payment is due. If you’re eyeing it for your primary residence, ensure you have a well-planned exit strategy, whether that means selling, refinancing, or paying it off with savings or an anticipated windfall.

Remember, while the prospect of low initial payments might be enticing, balloon mortgages come with undeniable risks. If you’re seeking affordability, consider alternatives like adjustable-rate mortgages (ARMs), FHA graduated payment loans, or VA loans. These might offer the financial relief you need without the looming threat of a massive balloon payment.

Today we are going to cover two terms we often hear used in the home buying process that are sometimes used interchangeably but there are some differences. So we will review “closing costs” and “predpaids” and what makes them different.

The Basics of Prepaids in Home Buying

Prepaids are the advance payments a homebuyer makes to cover specific future expenses before they come due. Typical examples include homeowners insurance premiums and property taxes.

While they are paid at closing, they don’t go directly to the vendor or provider. Instead, your lender will keep these funds in an escrow account. Over time, the lender will distribute payments from this account as required.

Here’s a closer look at standard prepaids:

Mortgage Interest: This is applicable when you close on any day other than the first of the month. The prepaid interest covers the days from closing to the end of that month and is held in escrow for your first mortgage payment. A savvy tip? Closing near the end of the month might save you some money.
Homeowners Insurance: Lenders usually require six to 12 months of homeowners insurance premiums at closing. The lender will then disburse this to your insurance provider monthly.
Property Taxes: Lenders estimate the property taxes you’ll owe and generally request two months of these taxes upfront. From your escrow, they will then forward these payments to your local government.
Initial Escrow Deposit: This deposit often includes two months each of homeowners insurance and property taxes. It ensures your escrow account has a healthy buffer for future bills.
For clarity, these prepaids are detailed in the closing disclosure document provided by your lender, typically three days before closing. You’ll find them on Page 2, Section F.

Deciphering Closing Costs

Closing costs, on the other hand, are the one-time fees paid directly to various parties involved in processing your mortgage. These can be to your lender (like application fees) or third parties (like home inspection fees).

Often, sellers might cover some of these costs as a gesture or part of the sale agreement. These are called seller concessions. However, it’s essential to remember that the buyer always foots the bill for prepaids.

Here’s a snapshot of frequent closing costs:

Loan-related fees: For processing and originating the mortgage.
Appraisal and Inspection fees: To assess the value and condition of the property.
Title-related fees: To ensure the property title is clean and transferable.
Attorney fees: For legal oversight and ensuring all documentation is in order.
Prepaids vs. Closing Costs: The Breakdown

In conclusion, while both prepaids and closing costs are payable at the purchase’s closure, they serve different purposes. Closing costs are direct payments for services rendered, whereas prepaids are essentially a buffer for future homeownership expenses, managed by your lender. Of course, we will guide you through all this when you are getting ready for closing. If you are looking to purchase now and want to review your options go to our website and complete our 60 second purchase analysis.

A lot of people don’t realize that it’s a good idea to watch your financial P’s and Q’s before closing your mortgage. Here are five common mistakes to watch out for to avoid any closing crises.

1. Making a big purchase, including furniture
If you’re about to close on a house, it’s not the best time to get a new car, boat or other expensive item. Even furniture or appliances — basically anything you might pay for in installments — is best to delay until after your mortgage is finalized.
Depending on your credit score and history, these transactions can lower your score, which can impact the interest rate and loan amount you receive. This could result in a higher interest rate for the next 15 or 30 years, or even having to come up with a larger down payment.
Bottom line: Wait to purchase a big-ticket item, because “this can ruin their chances of staying qualified for a loan,” says Patricia Martinez-Alvidrez, business development officer for Stewart Title in El Paso, Texas.
2. Opening a new line of credit
It’s not just big purchases that can alter your credit score. Opening a new credit card or closing an existing one can affect your standing, too. In the runup to your mortgage closing, lenders make an assessment of the credit risk they are taking on and go through several steps to assess that risk for each loan applicant.It’s especially important to protect your credit score if it’s low enough that you’re on the margins of qualifying for a mortgage at the start of the process. Any changes in that case can work against you and might make it impossible to finalize the loan.
3. Switching or quitting your job
Another major mistake to make when you’re about to close on a home purchase is changing jobs. This is because mortgage lenders examine your employment history for consistency, and providing additional documentation on employment to a lender can delay the closing.
If you have any control over your job situation, it’s best to stay put until after you close. A borrower who quits their current job might have to wait a couple of weeks before they can attempt to close again.
4. Disrupting the timeline
Closing on a mortgage is time-sensitive. Even if you’ve locked in your rate, that only guarantees things for so long. It’s important to keep on top of the schedule and make sure all of your paperwork is submitted on time. Otherwise, you risk losing the terms you agreed to and could have to start the process over again.
5. Taking out a personal loan
If you get a personal loan or co-sign a loan for someone else, you could also face hiccups before getting to the closing table. In some instances, the lender might turn you down for a loan altogether even if you were previously preapproved.
It depends on how your credit score and debt-to-income (DTI) ratio is impacted. A good DTI, in particular, is a critical factor in mortgage approvals. Lenders consider two types of DTIs:
Front-end DTI: Your monthly mortgage payment, including principal, interest, taxes, insurance and association fees divided by your monthly income
Back-end DTI: The sum of all your monthly debt payments divided by your monthly income
Depending on the amount of the loan payment, your back-end DTI could increase to a percentage that the lender is unwilling to accept. If your credit score is right above the minimum to qualify for a mortgage, a hard inquiry that results from applying for a personal loan could drop it to a point that makes you ineligible. Either way, there’s a chance you’ll be forced to walk away from the deal.

It’s not always smooth sailing when going from the mortgage application process to the closing table. However, there are actions you can steer clear of to minimize roadblocks and ensure your loan closes on time. You also should review your credit report, scores and identify ways to optimize your financial health to give yourself the best chance at securing a mortgage with competitive terms. And definitely give us a call if you’re in your closing and not sure 🙂