What happens in a balloon mortgage?

In a balloon mortgage, the structure of the loan is such that the borrower makes regular payments over a specified term, but these payments do not fully amortize the loan. Instead, they primarily cover interest, and a significant portion of the principal remains unpaid. At the end of the loan term, a large final payment, known as a "balloon payment," is due, which includes the remaining principal balance. This is why the balancing payments can increase significantly at maturity, as the borrower must pay off a substantial amount all at once.

The concept behind the balloon mortgage allows for lower monthly payments during the initial years, which can be appealing for borrowers. However, the large final balloon payment can pose financial challenges if the borrower has not prepared for it adequately or if market conditions have changed.

The other options do not accurately describe the key characteristic of a balloon mortgage. Establishing a fixed interest rate can occur in many types of mortgages, but it is not unique to balloon mortgages. Paying all principal upfront is not a feature of balloon mortgages, as they typically allow for reduced payments until the end of the term. Finally, while mortgage interest can be tax-deductible in many cases, this is not a defining trait of balloon mortgages. The significant increase in