Q: I am a real estate agent practicing in Maryland and the District. There is a lot of uncertainty in our office about the second trust provisions of both District and Maryland law. Can you advise as to what the law provides regarding these second trusts?
A: You are not alone in your confusion. Many real estate professionals are uncertain about the existing law, and although this column has written on the subject in the past, this is a good time to summarize the state of the second trust laws.
In the District, a second trust on residential property cannot have an annual interest rate or more than 15 percent. A balloon payment -defined as having all payments equal to or substantially equal to each other -is permitted only by a federal regulated financial institution or there the borrower is the "only/occupant."
Thus, if you own your own home and are selling it to a new owner, you are permitted to take a balloon note for an interest rate of up to 15 percent per year if you are actually living in the property.
There is an arbitrary distinction made between owner/occupants and all other owners. Thus, if you do noot live in the property, even if you are selling the property to a person who wants to move in and occupy, in the District you are prohibited from taking a balloon note.
This is extremely unfortunate. Most financing today involves some type of seller take-back. The D.C. City Council, in its wisdom, decided that sellers who live in their property should be entitled to the balloon, but sellers who are investors are not given that same benefit. Clearly, the council ignored the realities of the real estate financing market.
A balloon note is a very attractive method of financing. If you were to take back a second deed of trust, for example, in the amount of $50,000 at a 12 percent interest rate, to pay this off withing a five year period you would have to pay $1,112.23 a month. To pay this off in 30 years, you would only have to pay $514.31. Your buyer may be unable or unwilling to pay the higher 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, for example, on a 30-year payment schedule, but the entire balance becomes due and payable (baloons) withing the time period agreed upon -in this case five years.
One way of getting aroung the balloon restriction for a non-owner/occupant is to require only one payment at the end of the note period. Under this arrangement, you could still take back the $50,000 second trust, payable in full in two or three years, but you could not require monthly payments by the borrower.
At the end of the term of the note, the borrower would be obligated to make the principal and all interest payments. Clearly, if you need the monthly income, this arrangement may not meet your needs. However, your borrower may want to take advantage of the tax benefits, and may be convinced to voluntarily make monthly interest payment -although they cannot be required to do so.
There are four exemptions from the District usury laws. The balloon restriction and the interest rate ceiling does not apply if:
* The borrower is a not-forprofit corporation.
* The purpose of the loan is to acquire or carry on a business, professional or commercial activity.
* The purpose of the loan is to acquire real or personal property as an investment.
* The borrower is a religious society and the loan is made for the purpose of acquiring or making an improvement on any real or personal property.
The City Council is presently considering a revision of the usury law, including balloon payment provisions, and hopefully this matter will be straightened out shortly so that sellers and buyers in the District will not be restricted in the sale of property.
In Maryland, a seller may take back a balloon second trust, provided that the simple interest does not exceed 16 percent annum. The balloon payment schedule must be expressly disclosed to the borrower and agreed to in writing by both the borrower and the seller.
But there is a very new and novel amendment that will affect all Maryland loans entered into after July 1. The seller/lender must be required to postpone the due date of the loan, at the borrower's request, for a period not to exceed 24 months. The borrower must of course continue to make the monthly installments that are provided in the original loan agreement, and the seller/lender cannot impose any additional closing costs, processing or similar fees on the borrower as a result of the extension.
What this means for sellers in Maryland is that if they take back a second deed of trust containing a balloon payment, borrowers must be permitted a one-time two-year extension, merely if they request that extension.
This has significant consequences for buyers and sellers in Maryland, and should be carefully considered before a balloon transaction in entered into.
It is a tremendous opportunity for buyers, faced with the uncertain future of interest rates over the next few years, to extend the due date on their loan. However, the seller who wants to get his or her cash shortly may find that this objective can be frustrated for two more years.