Q: We are selling our house in the District and apparently have been caught up in these high-interest-rate, tight-money times. Our existing mortgage is assumable, and we are prepared to take back secondary financing to help our potential buyer make the purchase. However, we do not want to commit our funds for 20 or 30 years and are interested in a short-term balloon note. We have received conflicting opinions as to whether or not the balloon note is permissible in the District. Can you advise?
A: Unfortunately, legislative drafting in the District is not a model of clarity. The D.C. City Council, although well intentioned, refuses to focus on the economic housing issues affecting this city, and instead is concerned with the illusory consumer protections that usury laws provide.
Money is now very expensive, especially for long-term mortgages. The City Council recently enacted emergency legislation repealing the existing usury law, thereby permitting some element of competition to keep the rates reasonable. This original emergency legislation was consistent with the laws in Virginia and Maryland regarding mortgage interest rates.
However, within the past week, the council enacted emergency legislation permitting interest rates on mortgages to go up as high as 15 percent. This 15 percent ceiling is one of the highest in the country for mortgage loans. The District law is still considered emergency legislation, and the council will have another crack at the issue when the 90 days are over.
Turning to your particular question, however, it appears that the balloon note restrictions still apply on all mortgages other than first mortgages (first deeds of trust).
A balloon note is actually quite simple. If you were to take back a second deed of trust in the amount of $50,000 at a 12 percent interest rate, to pay this off within a five-year period you would have to pay $1,112.23 per month. To pay this off in 30 years, you would only have to pay $514.31. Clearly, your buyer may be unable to pay the high mortgage payment based on the five-year term. On the other hand, you do not want to commit your funds for the entire 30 years.
Thus, the concept of a balloon note has been developed. The mortgage payments are based on a 30-year payment schedule, but the entire balance becomes due and payable (balloons) within the time period agreed upon -- in this case five years.
In the District, because of some very serious frauds involving second deeds of trust, the City Council curtailed the balloon note several years ago for any loan over 8 percent. So although a second trust can be as high as 15 percent, the law states that the second trust must "contain a schedule of payments under which each payment shall be equal to, or substantially equal to, the other payments, and the intervals between payments shall be substantially equal. . . ."
For residential second deeds of trust, you cannot have a balloon payment if the interest rate is over 8 percent. Needless to say, when you can get more than 8 percent on your money at a local bank, you have to think long and hard about taking back a second trust at only 8 percent.
There are a couple of exemptions, however, which should be called to your attention. If the borrower is a not-for-profit corporation, or if the purpose of the loan is for business or investment purposes, the usury laws and these balloon restrictions do not apply.