What is a balloon payment?
A final/balloon payment is any final payment on a note in an amount greater than twice the amount of any of the six regularly scheduled payments immediately preceding the balloon payment date. [Calif. Civil Code §§2924i(d)(1), 2957(b)]
Balloon payment notes contain due date provisions calling for an accelerated payoff of the principal in a lump sum amount before the note balance has been fully amortized through periodic payments. Further, a note has a balloon payment it if contains a call provision giving the carryback seller or lender the right to demand the final payment at any time after a specified time. [CC §§2924i(d)(2), 2957(c)]
Limitations on balloon payments in consumer mortgages
Consumer mortgages are contrasted with business mortgages based on the purpose for which the funds are intended to be used.
A consumer mortgage both:
- funds a personal family, or household purpose; and
- is secured by a one-to-four unit residential property, whether or not occupied by the borrower or their family. [12 Code of Federal Regulations §1026.2(a)(19)]
Balloon payments in consumer mortgages have become rare due to Regulation Z (Reg Z) rules.
Mortgage lenders making consumer mortgages are mandated by Reg Z to qualify the borrower under stringent ability-to-repay rules (ATR).
Editor’s note – Small lenders operating in rural or underserved areas are exempt from Reg Z balloon payment rules.
Balloon payment notice and due dates
Some mortgages with due dates require a balloon payment notice.
A 90/150-day due date notice provision is required in notes containing a final/balloon payment provision with a term exceeding one year if:
- the note is carried back by a seller and secured by a trust deed on one-to-four residential units; or
- the note evidences a loan secured by a trust deed on an owner-occupied, one-to-four unit residential property.
A due date notice is not required, unless agreed to by both parties, on transactions including:
- carryback mortgages secured by any type of real estate other than a one-to-four unit residential property, whether or not owner-occupied;
- lender mortgages secured by any type of real estate other than owner-occupied, one-to-four residential units;
- open-ended credit secured by any type of real estate, such as a home equity line of credit (HELOC); and
- construction loans for any type of improvements. [CC §2924i(b)(1), (3)]
The due date notice is used to remind the owner of the secured property of a note’s final/balloon payment. The notice, while a reminder, gives the owner an opportunity to refinance or pay off the note. [See RPI Form 419]
Delivery and contents of the notice
Carryback sellers and lenders need to deliver the notice to the buyer or owner of the property:
- personally; or
- by first-class certified mail to the property owner’s last known address.
The notice needs to be given at least 90 days, but not more than 150 days before the due date. [CC §§2924i(c), 2966(a)]
If the notice is not timely delivered, the final due date is extended until 90 days after proper notice is given. No other terms of the note are affected. Thus, the accrual of interest and the schedule of periodic payments remain the same during the extended due date period. [CC §§2924i(e), 2966(b)]
If the owner defaults on a payment during the due-date extension period, the noteholder may initiate foreclosure.
The dollar amount of the final/balloon payment in a carryback transaction needs to be computed and disclosed to the buyer:
- first in a Seller Carryback Disclosure Statement handed to both the buyer and seller as an attachment to the purchase agreement, or for further approval before the close of escrow subject to cancellation on reasonable disapproval [See RPI Form 300, 2924i(e)]; and
- again in a written due date notice delivered at least 90 days, but not more than 150 days, before the balloon payment is enforced by the carryback seller. [See RPI Form 419]
Further, the carryback note prepared by escrow includes a statutory provision calling for the balloon payment due date notice. [See RPI Form 418-3; 2966]
