As "balloon" home mortgages begin to expire in the Washington area, real estate attorneys and foreclosure agents say they're seeing few of the "horror stories" told by some West Coast home buyers who used this method for short-term financing.
Real estate experts note, however, that much current refinancing simply involves a renewal of notes that will "balloon" again in several years. They say that notes with balloon payments now are involved in about 25 percent of all residential transactions in the Washington area, and they advise home buyers to engage in early and aggressive searches for permanent financing.
A balloon mortgage is one in which the amortization schedule does not extinguish the debt at the end of the mortgage term, leaving a large final payment, called a "balloon," to pay off the remaining principal. In a common balloon mortgage arrangement, a homeowner lets a buyer assume the existing mortgage. The remainder of the sale price is placed in a low-interest, short-term balloon mortgage, usually for between one and seven years, on the premise that low-interest permanent financing will then be available. At that time, the buyer must refinance the "balloon" sum.
Last year, approximately 66 percent of all second-home mortgages in the United States involved balloon payments at an average interest rate and term of 12 percent for five years, according to a study by the National Association of Realtors. Almost 80 percent of seller-financed house transactions involved balloons, nearly twice the rate for institutional lenders.
Balloon notes, which were common in pre-Depression years, were revived in California about 10 years ago. About six years ago, they spread to the Washington area, where a few of them are beginning to expire.
"The horror stories that I've heard about in California and in the Sun Belt have not occurred in this area," said Washington real estate attorney Bernard Kanstoroom. Washington homebuyers, he predicted, will not encounter serious problems with balloons because cautious real estate agents here have avoided the "flagrant abuses" of low-equity lending plans that he said doomed many West Coast mortgages. "For the most part," he said, "the buyer merely gets another balloon loan and postpones the day of reckoning."
Area real estate auctioneers say that while residential foreclosures are on the rise, few, if any of them involve balloon mortgages.
Washington real estate attorney Peter Kolker is less optimistic than Kanstoroom. "Individual cases can oftentimes be worked out, but there are certain things to worry about here," he said. Kolker noted that a continued tight money market could provide a bitter surprise for home buyers who arranged a balloon note on the assumption that interest rates would go down.
He also warned that widespread reports of West Coast foreclosures could panic Washington-area lenders into foreclosing on "marginal" balloon notes they hold.
In what is a classic case study of the struggle that may face thousands of Washington-area home buyers and financiers in several years, Kolker is trying to renegotiate a one-year balloon note that he arranged last March for a house he sold on behalf of a hospitalized client.
Several days ago, the home buyer, a Washington grocery clerk, told Kolker he was having trouble getting new financing for the loan, which expires March 16.
The clerk, whose family income is about $30,000 a year, bought the northwest Washington house for $47,000--$16,000 down, plus a 14 percent, $27,000 balloon note.
The buyers said mortgage lenders would not lend them the money right now, so Kolker has given them a 60-day extension to enable them to line up financing.
Kolker, who is a member of the Washington firm of Zuckerman, Spaeder, Taylor and Kolker, outlined alternatives for refinancing his clients' loan:
Preferably, the couple's mortgage lender will come through with a loan. At the going interest rate of 17 1/2 percent, it would raise their $325 monthly payment by only $70. But will the mortgage come through? "I wouldn't bet my last dime on that happening," Kolker said. "The problem is not the cost of the payment, it's just the absence of money."
Kolker could extend the existing 14 percent balloon. "But," Kolker said, "I can't keep rolling it over, because my client just needs the cash." He also noted that each year he extends the low-interest balloon he could "lose" up to $1,000 of his client's money because he'd forgo opportunities to put the $27,000 in a high-yield investment fund. "We'd be subsidizing these people," Kolker said.
He could extend the balloon at a higher interest rate, thereby increasing his yield and prodding the buyer to seek more permanent financing. Or, he might be able to work out a graduated-rate payment plan for the homebuyer. In both cases, however, he is stifled by the District's usury law, which puts a 15 percent interest cap on certain loans.
Kolker could provide the buyers with a new low-interest balloon loan for perhaps 40 percent of what they still owe, having them get market-rate financing on the other 60 percent, or $16,200. It might be easier for the buyer to find financing for the smaller amount, and Kolker's client would get $16,200 now.
Here, Kolker runs into several problems. The outside mortgage lender will almost certainly insist, he said, on being in "first place" in case of foreclosure, thus leaving Kolker with the "leftovers" of a foreclosure sale. "I'm back to square one," he said. "That's one of the perils of second-trust lending."
Kolker has considered the final, unpalatable, option--foreclosure. "I don't want to throw the people out," he said.