Stanzer Knox refinanced his home in 2006 with a 30-year $185,000 mortgage - or so he thought. Mr. Knox soon discovered that he had agreed to pay the mortgage on his Minnesota home within the 30-year period, but he had 40 years' worth of payments to make. At the 30-year point, Mr. Knox would have to make a lump-sum payment of $121,062.58, equal to 120 monthly payments.
The balloon loan allows the borrower to pay less or no principle each month that falls short of the entire payment during the amortization period. The borrower makes a balloon payment at the end of the amortization period to pay off the remainder of the loan. Lenders sell this product as a means for homebuyers to get more for their money and suggest they simply refinance with a traditional mortgage before the balloon payment comes due. The lender's strategy assumes that the buyer is able to obtain a traditional mortgage in the future and, often, the borrower may not realize the additional fees and closing costs involved in refinancing.
On its face, the balloon loan is a tempting prospect. The lower payments are an attractive incentive to refinance an existing home or to purchase an even nicer house. However, over the long run, balloon loans often put mortgage holders in a difficult position. In some cases - as with Stanzer Knox's refinancing agreement - the lenders do not adequately explain the terms of the lengthy, complex mortgage documents.
Balloon mortgages were popular during the 2000s and were one of the predatory lending practices that resulted in the real estate market bubble bust. The Office of the Minnesota Attorney General advises borrowers to beware of these potential predatory lending situations:
- A lender convinces you to borrow more than you can afford to pay back.
- Adjustable Rate Mortgages ("ARM") could suddenly increase when interest rates increase.
- Interest-only loans eventually require principle payback at much higher monthly payments.
- You may not be able to afford a balloon payment when the time comes.
- A broker may persuade you to refinance even though the deal does not benefit you - an illegal practice called churning.
- An inflated appraisal can saddle you with debt even after you sell your home.
An experienced Minnesota real estate lawyer can protect you from predatory lending practices and pursue lenders who violate the law.