Jane and Ron just won their own personal balloon race.
And, as it turned out, they were able to glide to the finish line. A year ago, when they first started contemplating the necessity of refinancing their "balloon" note, they didn't think it would be so easy.
They envisioned complicated financing mechanisms, and in July even sent a sob-story letter to the seller of their home who had provided the balloon financing in the first place, asking for more financing.
But then in August, rates started coming down--fast. And as their December deadline approached for refinancing the balloon note, the procedure started looking easier and easier.
Eventually, they got a 13 3/8 percent fixed-rate mortgage, paid three points to the new lender, Steed Mortgage Co., and paid off the note to the seller. Still expensive--the closing costs amounted to about $8,000--but relatively simple.
The example of Jane and Ron illustrates how the drop in interest rates has changed the equation in balloon refinancing, making it far easier than anyone thought it would be only a few months ago and possibly saving large numbers of people from losing their homes. But it also shows how basic luck and timing plays a big part in the success of this mechanism as a future method for getting into a house when long-term fixed rates are high.
It's still a gamble for anyone planning on using this short-term financing method in the future, and one that Jane and Ron at the beginning of the year feared they might have made a big mistake on.
A balloon note is one in which the rate is fixed for only a short period, generally two to five years, and after that time the entire principle of the mortgage is due in one lump payment to the lender. As a practical matter, this means the loan must be refinanced at the end of the period.
Sellers started using the method increasingly two or three years ago when traditional 30-year fixed mortgage rates were going ever-upward, taking back financing themselves at below-market rates for a short period to get people into homes. The theory was that rates would have to decline before the note came due, and buyers could refinance easily.
But as it turned out, rates continued to go up, and buyers began to realize that it might be more difficult than they ever anticipated to get affordable long-term financing for their homes. In some cases, the threat of foreclosure was very real for people who could not afford the monthly payments at market prices and could not even sell to get out from under the debt because no one else could afford them either.
In California, where the balloon method was used first, these balloons started bursting this year, and people there did lose their homes. Fears spread to other parts of the country that balloons were a financial time-bomb which would explode in the faces of large numbers of buyers.
With the drop in interest rates, this has at least been forestalled if not completely averted.
When Jane and Ron started their search for $108,000 in refinancing, market rates were around 17 percent, while the interest on the balloon note was 12 percent. But this couple had an advantage over most. They are both professional people with an above-average family income. In addition, Jane is involved in housing finance professionally and had the added help and advice of experts she deals with regularly.
For this reason, The Washington Post decided to follow their search for balloon financing from beginning to end (with the understanding that only their first names would be used) to see how someone with a high degree of knowledge but no guaranteed source of mortgage funds would go about it.
They didn't wait until the last minute, but started in March looking into a Loyola Federal Savings and Loan program that was financed with Maryland state pension fund money. The rate of 15 per
It's still a gamble for anyone planning on using this short-term financing method in the future, and one that Jane and Ron at the beginning of the year feared they might have made a big mistake on. cent at the time looked attractive, but the S&L was charging 6 points up front and that would have cost $6,000 on their loan. And the plan, as it turned out, wasn't open to refinancing.
By May, the couple was seriously considering a plan involving graduated payments over the first five years, with the interest rate rising over that period from 12 3/4 percent to 16 1/2 percent and then staying at that rate. If they had locked into that plan then, their payments would have started at about $1,100 the first year and increased to about $1,600 by year five. The points would have cost more than $5,000.
"It's difficult to know which way to bet," Jane said at the time. They were weighing the choice of fixing in at a rate or going to an adjustable-rate loan, in which their payments would decline automatically if rates did. Or, with the graduated interest-rate plan, they could refinance again before it got to the 16 1/2 percent level if rates went down enough. That would make sense if rates were going to decline, as some economists at the time were predicting.
"But I believed the economists the first time around. That's why I'm stuck now," she said, referring to the fact that they, like so many others, had counted on rates falling over the period of the balloon note.
In June, they were considering a more complicated plan which started their payments at $1,100 and more than doubled to $2,400 in five years but then stayed the same, with the mortgage paid off in 19 years. Later, they decided the acceleration was too fast and the payments too high in the early years.
It was then they decided to ask the sellers to lend them $30,000 at 13 percent for 10 years, to combine with $90,000 from the graduated-interest plan they were looking at in June. The couple even thought they might get a bonus out of this plan--contemplating using $10,000 of this total to finish the remodeling of their kitchen or maybe even as a downpayment on another house. Still, if this plan had gone through, they would have ended up increasing their monthly payments from $1,100 to $1,400 in the process of refinancing.
About this time, the couple was feeling resentful of the real estate agents that advised them to buy with a balloon in the first place.
"Realtors set up the 12 percent rate three years ago, and now they are nowhere in sight," Jane said at the time. "I could lose my home, and they are nowhere around."
When they bought, conventional rates were 13 7/8 percent, and they didn't think they could afford it. Along about July, with five months to go on the balloon note, they were sorry they had not grabbed that fixed rate.
But things were looking up in August, and they noted with some relief that they could get a fixed rate of 15 3/4 percent--still far higher than the 12 percent they had but not as unthinkable as the 17 percent a few months earlier.
Then the government-set FHA rate started to drop . . . and drop . . . and drop.
When it went to 14 percent, they considered going straight FHA, though the large amount of points at the time finally discouraged them. But when the conventional rate fell to 15 percent, they decided that was the way they wanted to go--the old-fashioned, traditional, non-adjustable, non-seller-financed, fixed-rate, 30-year standby.
"I'd rather be sure," Jane said in September.
But as it turned out, rates continued to go up, and buyers began to realize that it might be more difficult than they ever anticipated to get affordable long-term financing for their homes.
The question then became how long to wait to refinance, as it looked like rates would continue to fall for awhile.
And fall they did, to the point where the couple was able to refinance at 13 3/8 percent plus three points. Their monthly mortgage payment went from $1,120 to $1,226, which they can handle easily.
And now they can even crow that their gamble two years ago paid off. The rate then was 13 7/8 percent, so they would have been paying $1,280 on that all this time. And since it was seller-financed originally, they got a two-year delay in payment of many of the closing costs charged by an institutional lender.
In the end, it's rather like the game of black jack. It helps to have skill--but it's better to have luck.