Is a Balloon Loan better than an ARM?

In most cases, balloon loans are not better than ARMs. There are risks associated with both types of mortgages, but those risks are greater with a balloon mortgage. Here are some reasons why:

First, there's a large payment due at the end of a balloon mortgage. Unless you know you'll be coming into a large sum of money before then, you'll need to refinance the amount due.

Here's an example: a 5-year balloon mortgage for ,000 at 6.5% has a final payment of over ,000. If you can't pay it (and most people can't), you'll have take out a new loan for that amount. That could be tricky if property values decrease in your area. In addition, lenders don't have to refinance a balloon mortgage if you've been late on even one payment in the final year.

Second, the initial rate on a balloon is usually higher than the introductory rate of an ARM. And you can easily avoid the higher "post-introductory" rate by refinancing the ARM to a fixed rate mortgage.

So the bottom line is this: regardless of whether you get a balloon loan or an ARM, you'll likely refinance the loan. There's more risk in trying to refinance a balloon mortgage, and if you're unable to refinance, you have to pay that large lump sum or you could lose your house. If you're unable to refinance an ARM, you may get stuck with a higher interest rate, but you'll still have a mortgage and a house.