Case Study: Balloon Payments

Mortgages with balloon payments are arranged so that after making certain number of regular payment (often five or seven years worth, sometimes 15), the borrower must pay off the remaining loan balance in its entirety, in one balloon payment. Predatory lenders have used balloons to sell the borrower on the low payment, without making it clear that this payment does not cover the principal owed.

There are specific circumstances where balloon payments make sense for some borrowers in loans at A rates, but for most borrowers in subprime loans they are extremely harmful. Balloon mortgages, especially when combined with high interest rates, make it more difficult for borrowers to build equity in their home.

After paying for some number of years on the loan, with the bulk of the payments going, as they do in the early years of a loan, to the interest, homeowners with balloon mortgages are forced to refinance to make the balloon payment. They incur the additional costs of points and fees on a new loan, and they must start all over again paying mostly interest on a new loan, with another extended period, usually thirty years, until their home is paid for.

In addition, many borrowers are unaware that their loan has a balloon payment, that their monthly payments are essentially only paying interest and not reducing their principal, and that the balloon will ultimately force them to refinance.

Joe and Mary are on fixed income. They took out a 15 year balloon loan in 2005 and received an $89,250 loan at 6.89% interest from a lender. After fifteen years of paying $587 a month for a total of $105,660 they will owe a balloon payment of $65,780.

15 year Loan with an adjustable rate

Interest only Loan

7 year Balloon Loan

30 year Loan with a Fixed interest Rate

1. Would you discuss the remaining loan program options with the borrower? Why or Why not?

2. Are there any borrowers who would be ideal to reap the benefits and manage the risks of these nontraditional loans; i.e.. IO, balloon, ARMs, etc.?