Question:

Is a 7 year adjustable rate mortgage (7 year ARM) better than a 7 year balloon?

Answer:

A 7 year adjustable rate mortgage (7 year ARM) and a 7 year balloon both have their own unique features that make them useful in different ways, but they are often used as alternatives. For both, the fixed rate period expires in the 7 year and the loan has to be refinanced, repaid or the rate adjusted.

A 7-year Adjustable Rate Mortgage (ARM) Pros and Cons

One advantage a 7 year adjustable rate mortgage (7 year ARM) has over the 7 year balloon is the rate cap providing protection in the unlikely event that inflation becomes a double digit - it has happened throughout history and could happen again, although chances are pretty small. In that case the 7 year ARM rate would be limited to the life cap of the loan, while a balloon will have to follow the market rate.

Another advantage of the 7 year adjustable rate mortgage over the 7 year balloon is that sometimes it is possible a refinance at the end of the 7 year period won't be needed while with a balloon refinance or repayment of the balloon is obligatory at the end of the balloon term.

A disadvantage of the 7-year balloon over the 7 year adjustable rate mortgage (7 year ARM) is that if the borrower defaults in the last year before the balloon term becomes due, the lender may refuse to refinance the balloon and demand payment in full.

On the whole, a 7 year adjustable rate mortgage may be a little more expensive, but a balloon comes a little riskier. If you are certain you are moving out the house within 7 years, you could try a balloon as it is cheaper; if you have any doubts about it, you'd better do a 7-year ARM.

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