Why would he finance with a balloon loan?

Question

I want to make an offer on a home that isn't yet on the open market, but the owner is in financial difficulties. I have to wait for my loan application to be approved before I talk to him. Meanwhile the agent in the area that I have consulted tells me she managed to talk with him briefly, and learnt that he is in difficulty because he can't meet a balloon payment.
Not wanting to show my ignorance I said no more then looked up a definition.
Why would he have taken out this type of loan instead of a home equity one? Does he not have an option to negotiate to change the payment for another loan?

Answer 1

To answer your last question first, some lenders will allow the conversion of the balloon payment into a traditional loan when the time comes, but it has to have been a stated option beforehand, and the probability would be at much higher interest rates.
At the time he took the loan put, he probably forecast one of two options- that he would sell that property prior to when the balloon was due (5 to 7 years later is the norm, although there are some 15 year periods) or he was expecting a financial windfall in that period, an inheritance, large dividend payments, something of that nature. So it made sense at the time, with the payments calculated over 30 years, meaning easy low repayment schedule in years 1 to 5 or 7, and a low down payment.

A real risk for the first time home owner or investor who has made a bit of a gamble or doesn't put something aside right from the start to ensure the balloon can be paid later.
If he can't refinance , he has to sell, regardless of the market
conditions, maybe at a price less than anticipated, or face foreclosure.
often losing his equity or most of it.

Answer 2

Balloon loans frequently offer the possibility of a much lower payment in the beginning, including a lower interest rate - with the balloon coming up at something like 3 or 5 or 7 years down the road. This feels pretty good during the low payment period.

People who are planning to sell or refinance before the balloon is due see a benefit to these loans. They are gambling that properties will appreciate in value, and interest rates will decrease, or both.

Personally, in today's market where it may be difficult to sell at will, or refinance for a better rate (since rates are rising) a balloon mortgage may not make good sense.

But there was certainly a time when it seemed like a good idea.

Answer 3

Typically a balloon loan works well for somebody whose cash-flow is limited for the moment, but who expects to come into a large amount of cash in the future with which he will pay off the loan balance.

Another possible motivation is that he knows he is credit-worthy (aside...my conjecture only...sounds like he might not be) and expects interest rates to fall between now and the balloon payment and hopes to re-finance at a lower rate at that time.

Answer 4

When I had a balloon mortgage it was because the seller carried a contract and didn't want to wait forever for his money.
He took a lien on my old house so when I sold it I was required to pay the mortgage he carried. I didn't have an option to refinance because I had mortgages on my new and old houses and the one that was a balloon on another property so was out of credit.