Balloon mortgages have five- or seven-year terms, but are amortized over a far longer period, typically thirty years. This means lower monthly payments for the borrower, but a hefty lump sum due at the end of the initial period, hence the term "balloon." A balloon rider is the section of a promissory note that spells out the borrower's options for refinancing at the end of the term.
According to the Mortgage Professor, a balloon mortgage looks very similar to a 30-year fixed-rate mortgage, as it results in identical monthly payments. The major difference between a balloon and a fixed-rate product is that, on the loan maturity date, the entire outstanding balance of a balloon mortgage must be repaid in full. This typically requires the borrower to refinance, or sell his home to meet the debt. There are two types of balloon mortgage, a 7/23 and a 5/25. The figures add up to the number of years over which payments are amortized -- 30 in each case. The first number is the number of years until the loan maturity date, when the balloon payment falls due.
A mortgage rider, also known as an addendum, is a standard document affixed to the principle mortgage document that explains certain terms and conditions of the mortgage. A balloon rider identifies the mortgage product as a balloon mortgage. It typically contains refinancing provisions, allowing the borrower to extend the term of his loan, or take out a new one, at the end of the initial period as an alternative to paying the balloon lump sum. Balloon riders are not lengthy, typically a page or two long.
The majority of the wording in a balloon rider deals with the borrower's right to reset his loan at the end of the term. Put simply, this means that he can opt to take out a new loan instead of paying the balloon sum. Typically, such provisions are conditional rather than automatic. The Freddie Mac standard rider lists the conditions a borrower must satisfy before he can exercise the right to reset. The borrower must still own and occupy the house. He cannot be delinquent on his loan payments, and cannot have been more than 30 days late on any of the 12 payments immediately preceding the note maturity date. There can be no clouds on the title, and the modified interest rate calculated in accordance with the terms of the balloon rider cannot be more than 5 percent above the existing rate.
Understanding the Rider
As with any legal document, it is crucial that a borrower reads and understands what he is signing. This is especially true in the case of a balloon rider, as the majority of its provisions do not take effect until the note maturity date, five or seven years in the future. As the Freddie Mac universal balloon rider shows, a lender might on the face of it commit to refinance the loan at market rates at the end of the initial term, but in fact the lender is under no obligation to do anything other than call in the balloon lump sum, if the borrower does not meet the strict reset criteria.
- Comstock/Comstock/Getty Images