Know the risks of balloon mortgages

Usually home buyers take out fully amortized mortgages whenfinancing their home purchases. A fully amortized loan is paid offin periodic payments of principal and interest over the loan term,often 30 years. A balloon payment mortgage is one that has a finalpayment that is significantly larger than the other periodic(monthly) payments. In some cases, the balloon payment is asubstantial amount of money.

Owner-carry-back loans often have balloon payments. Theyfrequently are interest-only loans. This means that during the timethe buyers are paying on the loan, none of the principal (the amountborrowed) is paid back. So, if the seller carries a $50,000 mortgagefor you with interest-only payments, you'll owe the seller the entire$50,000 that you borrowed when the loan comes due.

There are a couple of popular institutional loan products thathave balloon payments. One is the 30-year loan that's due in 5 or 7years. The interest rate on this mortgage product is usually a bitlower than you'll find on conventional 30-year fixed-rate mortgagesthat are due in 30 years. The monthly payments on the short-termmortgages are amortized on a 30-year basis. But, at the end of the 5or 7 years, a large balloon payment is due.For example, on a mortgage with a 7.5 percent interest rate,approximately 92 percent of the original mortgage amount is due after7 years. Let's say you borrowed $200,000 at a 7.5 percent. At theend of seven years, if you haven't already sold the property orrefinanced, you'll owe the lender approximately $184,000.First-time tip: Make sure if you do take a mortgage that has aballoon payment that the due date doesn't come too quickly. If youcan't repay the balance when it's due, you could lose the property ina lender foreclosure.Some "30-due-in-7" loans have a conversion option. Ifexercised, the lender extends the mortgage for another 23 years at anew interest rate. The new interest rate is determined according toa conversion formula that varies from lender to lender.Another popular mortgage these days is a second mortgage for anamount equal to 10 percent of the purchase price. Let's say you'rebuying a home and need a loan for 90 percent of the purchase price.Ninety percent loans often require the borrower to pay mortgageinsurance to protect the lender in case the buyer defaults. If,instead of getting a 90 percent mortgage, you get an 80 percent firstmortgage and a 10 percent second mortgage, the first lender oftenwon't require the buyer to pay for the insurance.Most conventional second mortgage lenders offer loans that aredue in 15 years. Since the monthly payments on a fully amortized15-year mortgage are higher than most buyers can afford, these loansoften have monthly payments that are amortized over a 30-year basis.This lowers the monthly payment amount, which makes it easierfor buyers to qualify for the financing. But, at the end of 15years, if you were to keep the loan that long, a balloon paymentequal to approximately 75 percent of the initial loan amount would bedue on a mortgage with a 7.5 percent interest rate.The closing: If you're planning to pay a balloon payment byrefinancing, don't wait until the last minute. Interest ratesfluctuate, and future rates can't be predicted with certainty.Real estate broker Dian Hymer writes from Oakland, Calif. She isthe author of Starting Out, The Complete Home Buyer's Guide,(Chronicle Books).