There are some mortgage loans that are balloon loans. This means that when the loan matures, there is a mortgage balance that will require financing. It is the responsibility of the borrower to obtain the refinancing
What is the added risk associated with a pool of loans backed by balloon loans?
A balloon loan is a long-term loan, often a mortgage, which has one large payment (the balloon payment) due upon maturity.A balloon loan will often have the advantage of very low interest payments, thus requiring very little capital outlay during the life of the loan. Since most of the repayment is deferred until the end of the payment period, the borrower has substantial flexibility to utilize the available capital during the life of the loan. However, the major problem with such a loan is that the borrower needs to be self-disciplined in preparing for the large single payment, since interim payments are not being made.
Given the above description of a balloon loans with a large payment, it stands to reason that a pool of loans backed by balloon loans will pose a greater risk for subordinate or mezzanine certificates. This is because subordinate loans will absorb any short in cash flows that might result from making the balloon payment.
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