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A balloon loan is a type of short-term loan. Initially, it works like
a traditional mortgage, requiring regular monthly payments of principal
and interest. Then, after a period of time (usually between 3 to 10 years),
it becomes 100% due. At that time, the borrower must pay the loan off in cash
(referred to as the balloon payment) or refinance.
Borrowers who take on a balloon loan assume that they will have the funds a
few years later, when they must make the balloon payment. If they do not have
the funds (or cannot acquire them), they risk losing the home. This can occur,
for example, if the housing market changes and it becomes unexpectedly difficult
Payments for a balloon loan can be based on a
or on an
adjustable-rate mortgage (ARM)
. In either case, the interest rate on a balloon
loan is usually lower than the interest rate on a normal 30-year, mortgage.