What is a balloon loan?

One type of mortgage, known as a balloon loan, appears at first blush to be somewhat like a hybrid loan. The interest rate is fixed, for example, for five, seven, or ten years. However, and this is a big however, at the end of this time period, the entire loan balance becomes due. In other words, you must pay off the entire loan. Borrowers are attracted to balloon loans for the same reason that they are attracted to hybrid or ARM loans -- because balloon loans start at a lower interest rate than do fixed-rate mortgages. Buyers are sometimes seduced into such loans during high-interest-rate periods or when they can't qualify for or afford the payments of a traditional mortgage. Balloon loans can blow up in your face. You may become trapped without a mortgage if you are unable to refinance (obtain a new mortgage to replace the old loan) when the balloon loan comes due. You may have problems refinancing if, for example, you lose your job, your income drops, the value of your property declines and the appraisal comes in too low to qualify you for a new loan, or interest rates increase and you can't qualify for a new loan at those higher rates. The one circumstance under which to consider a balloon loan is if you absolutely must have a particular property and the balloon loan is your one and only mortgage option. If that's the case, you should also be as certain as you can be that you'll be able to refinance when the balloon loan comes due. If you have family members who could step in to help with the refinancing, either by cosigning or by loaning you the money themselves, that's a big back-up plus. If you must take out a balloon loan, get as long a term as possible, ideally for no less than seven years (and preferably for ten years).

What is a hybrid loan?

Hybrid loans or what lenders sometimes call intermediate ARMs start out like a fixed-rate loan (the initial rate may be fixed for three, five, seven, or even ten years) and then the loan converts into an ARM, usually adjusting every six to twelve months thereafter. Loans called 7/23s (which are fixed for the first seven years and then have a one-time adjustment and remain at a fixed rate for the remaining length of the loan term) are also available.