Although the housing market has recovered to a certain extent, foreclosures still remain a problem in the United States. There are a number of reasons that this continues to be the case, but a big one is something known as a “balloon payment”. Below, we’re going to examine what a balloon payment is, and how it could affect your status as a homeowner.
What Is a Balloon Payment?
Balloon payments are not specific to mortgages, as they can be a part of a variety of loans. In essence, a balloon payment is a large payment that is due at the end of a loan. This payment is made to make up the outstanding balance of a loan that has not been amortized.
With respect to mortgages specifically, these balloon payments have been used to do a variety of things. For one, lenders have used them in the past to offer special rates to borrowers, given that the balloon payment fundamentally alters the entire structure of a given loan, giving the lender a degree of flexibility. These balloon payments, for the most part, are included not with the expectation that they’ll be paid in full at the end of the loan – as they’re almost always quite exorbitant – but with the belief that balloon payment will act as a precursor to additional financing.
So, What’s the Problem With Balloon Payments?
In a way, you can look at the balloon payment as a means of punting the ball to a later date. By giving the lender flexibility, that lender can then offer more incentives to the borrower to take the mortgage being offered. In return, the balloon payment essentially functions as a mortgage to be determined later, given that most borrowers will be unable to make the payment in full at the conclusion of the initial loan.
On the surface, it sounds like an okay deal, but there are a number of problems. As many well know, mortgage rates are constantly in flux. So, while the terms of the initial mortgage with the balloon payment may make sense for the homeowner, there’s no guarantee that the subsequent mortgage that will be used to pay the balloon payment will make equal sense. In the end, this can – and often does – lead to a borrower paying significantly more for their home than they initially anticipated.
There is, however, a much deeper problem. It’s not just that mortgage rates change over time, it’s that the mortgage market itself and its standards change over time as well. Before the financial crisis, mortgages were available to a much wider array of Americans than they are now. During that time, lending standards were far more lax than they are today, which is, in part, responsible for the prevalence of mortgages with balloon payments in the first place.
This creates a curious problem. While a homeowner may very well have qualified for a specific mortgage before on the house that they own, there is no guarantee that with the change of standards they’ll be able to qualify for a mortgage on that property today. As a result, that homeowner will be confronted with the balloon payment in its entirety, without the means to borrow money in order to pay it off. The result? That homeowner may find his or herself facing foreclosure, even though he or she was able to keep up with prior mortgage payments.
What To Do If You’re Facing a Balloon Payment
If there is a balloon payment coming due on your mortgage, you have a few options for dealing with it. As we’ve already discussed, you can go the anticipated route of paying off the balloon payment by refinancing with another mortgage. However, if this option is not available to you for whatever reason, there are other methods for dealing with the balloon payment available to you.
First, you can attempt to sell your home. By selling your home, the purchaser will become responsible for paying off your existing loan, which means the balloon payment will be taken care of. Of course, selling may not always be an option. For one, you may not be able to get fair value for your home, particularly if the area in which you live has had foreclosure issues. Also, you may simply not have enough time. Selling a home can be a lengthy process, and if your balloon payment is due in the short-term, you might find yourself between a rock and a hard place.
Some mortgages that were issued that contained balloon payments also contain an option for conversion. If you are unable to qualify for a new mortgage this may be the best option available to you. Through this option, you can convert the structure of your existing loan into a standard 30-year mortgage. Availing yourself of this option, though, requires that it is actually an option. Not all mortgages that contain balloon payments offer the borrower the opportunity to convert to a standard mortgage.
What Is the Future of Balloon Payments?
While balloon payments may continue to be used in other debt situations, they’re mostly on their way out with respect to mortgages. The provisions of the Dodd Frank Act have made it much harder for lenders to offer these kinds of mortgages. This is because lenders will have to be completely upfront about the nature of the balloon payment, and they are expressly forbidden from offering mortgages that contain such a payment with promotional interest rates.
There is one hope that remains for homeowners facing balloon payments who have no other avenue out of their present situation other than foreclosure. The emergence of the real estate crowdfunding market is creating a new avenue for homeowners to secure the loans necessary to keep their homes. If you find yourself in this situation, then it would behoove you to research the real estate crowdfunding market further. It may just offer the beacon of hope that you and your family have been looking for.