Mortgage loans may be structured as amortizing, balloon or bullet loans. A residential mortgage is generally an amortizing loan, in which the loan payments of principal and interest are made in regular installments over the term of the loan until its maturity date. Commercial mortgages generally do not amortize over their term, instead they are structured as a partially amortizing balloon or bullet loans.
A balloon loan allows for periodic level payments that are relatively low during the loan term and a relatively large final payment (the “balloon”) at the loan’s maturity. A bullet loan (interest-only loan) calls for payment of only the interest on the principal balance during the loan term and principal repayment (the “bullet”) at maturity or loan termination.
A prepayment penalty is a charge that the lender levies on the borrower if all or part of the loan principal is repaid before its due date, it typically being charged only on commercial mortgage loans. The U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) prohibits prepayment penalties for most residential mortgage loans unless all of the following conditions are met:
- It is a fixed-rate loan or the loan’s annual percentage rate (APR) cannot increase after the loan has been extended;
- The loan is a qualified mortgage, which is a loan that has certain, stable terms that make it affordable; and
- The loan is not a higher-priced mortgage loan, such that it has an annual percentage rate higher than the average prime offer rate.