With a traditional mortgage, each monthly payment
comprises principal plus interest. In the early years of the loan,
most of the payment goes for interest. Gradually, more and more
of the monthly payments go toward principal. At the end of the term,
the loan is completely repaid. This process of paying principal
and interest until the loan is paid off is called amortization.
Some equity debt is not fully amortized. The principal
is not paid off at the end of the loan term. This is especially
the case with some credit lines. At the end of the loan term, often
15 years, all of the outstanding debt is due in a lump sum. This
is called a balloon payment.
If you can't pay your balloon off at once, you could
lose your home. Most people get out of this by refinancing the loan's
outstanding balance into a home equity loan or another line of credit.
If rates are high or your credit has gone sour, and you can't refinance
the balloon payment, you could be forced to sell the home to pay
off the balloon. Fortunately, this is a rare occasion.
Be careful with loans with balloon features. Steer
away from them if you can. If you end up getting a credit line with
a balloon payment, don't let it catch you by surprise.