What is a balloon mortgage?

A balloon mortgage is characterized by having a large payment due at the end of a loan term after making smaller payments throughout the duration of the loan. This means the borrower pays smaller monthly amounts, typically just covering interest or a portion of the principal, but at the end of the term, they are required to make a significantly larger “balloon” payment that settles the remaining balance of the loan.

This structure can be advantageous for borrowers who may anticipate having more funds available at the end of the term or who plan to refinance prior to the balloon payment's due date. However, it also carries risks, as the borrower must be prepared to make that larger payment or find another solution when the time comes.

The other options describe different types of loans that do not accurately represent the unique characteristics of a balloon mortgage. For instance, loans with fixed monthly payments for their entire term lack the large final payment component. Similarly, loans with no payments required until maturity do not follow the structure of smaller payments leading to a lump sum at the end. Lastly, the concept of a loan that automatically converts to an adjustable-rate mortgage (ARM) does not align with how balloon mortgages are structured, focusing instead on a fixed payment plan leading to a large final payment.