Friday, December 15, 2006

5 Year Balloons - Losing Your Home

My partner's co-worker is losing her home.

No, she didn't miss too many payments. No, she didn't fail to pay her real estate taxes. She just picked the wrong mortgage when she bought her home. She chose a 5 year Balloon.

A Balloon Loan is somewhat like a 30-year mortgage. Both loans have payments that are amortized for 30 years. The difference is that with a Balloon, after the specified time period is up (5 years for a 5 year Balloon, 7 years for a 7 year Balloon, etc) the remainder of the loan becomes due in full (What is a Balloon Loan).

That means that after 5 or 7 years of faithfully making your payments, you have to come up with the entire amount that is still owed on your loan. The amount that is still owed is usually a very large sum of money, because not much of the principal has been paid off in only 5 or 7 years.

Many people choose these types of loans because the interest rate is a little bit lower. They figure they will want to sell the house within 5 years, or they think it will be easy to refinance the loan if they decide not to sell the house. All too often, neither is the case, and they end up needing a huge hunk of cash.

It's not uncommon for the bank or Credit Union that holds the Balloon to decide NOT to refinance the loan. In this case, if you haven't prepared yourself you will be rushing around desperately trying to find a bank that will refinance your loan in a short period of time.

If you fail to find a bank in time, you must either pay the loan in full, or lose your home.

This is what happened to my partner's co-worker. She had no clear idea of how the Balloon worked, so she didn't research and pursue a new loan. She waited till the last minute and was shocked to find that she was not only going to lose her home, but her credit rating was going to be decimated as well - by defaulting on the loan.

My advice is to stay away from Balloon loans. With a 30 year fixed-rate loan, if you decide you want to sell the house after 5 or 7 years, you will have time to do it without the spector of doom hanging over your shoulder. And, you won't be homeless on Christmas.