Can You Lose Your Home Due to a Balloon Mortgage?

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You can use a balloon loan to buy or to refinance a residential property. Balloon loans have terms that range from five to 30 years. The loan term begins with a phase during which you only have to make interest-only payments on the loan. When this period ends, you have to make a one-time principal payment. With some balloon loans, such as home equity lines, you can make principal payments prior to the end of the loan term. On other balloon loans, you incur prepayment penalties if you pay down the principal during the interest-only term.

A balloon loan becomes problematic if you cannot afford to pay off the principal when the loan term ends. State laws on foreclosure vary, but your lender can begin the foreclosure process if you fail to pay off the debt within 30 days of the due date. If you have a balloon loan in the second lien position behind your first mortgage, the lender can foreclose even if you have always paid your first mortgage on time. Therefore, you put your home at risk even if you take out an equity line in second or even the third lien position, because all lien holders have the right to foreclose.

Some investors take out balloon loans on properties they intend to sell for profit. You can make small monthly payments while you own the home and use the surplus cash to renovate the property and sell it before the balloon payment comes due. However, if property prices fall, you may find that the balloon payment exceeds the property value. You can only sell the home if you pay down the loan balance or if your lender agrees to a short sale. In a short sale transaction, the lender allows you sell the house for less than you owe, but a short sale can dramatically reduce your credit score.

During the recession that began in late 2007, home prices fell and this left many people with balloon loans in a situation in which their mortgage debt exceeded their property value. Typically, you cannot refinance a debt that exceeds the property value, but the federal government rolled out a series of initiatives that encouraged lenders to modify loans, including balloon and interest-only loans, to prevent homeowners from going into foreclosure. Modifications can involve principal forgiveness or the lengthening of the loan term. Additionally, outside of these programs, some lenders consider loan modifications for troubled homeowners on a case-by-case basis. Therefore, if you cannot afford to pay down the loan, cannot sell and cannot refinance the debt, a modification may present you with a possible alternative to foreclosure.