A promissory note is a document providing for payment of an obligation to another, usually in writing, and subjecting the borrower to legal liability if it is not paid in a timely fashion under the terms of the note.
The terms of the note depend on the negotiations between the parties but one type of common note provides for a lump sum payments at a specified time, often but not always including all accrued interest. Such lump sum payment are called “balloon payments” in the industry and if secured with a Deed of Trust, California law imposes strict requirements on the lender who plans to receive a balloon payment on a California note and enforce lack of payment by foreclosure on the Deed of Trust. This article discusses the civil code requirements imposed upon the lender, and the ramifications if the lender fails to meet those requirements.
Basic Law of Notice of Balloon Payment Requirements
California Civil Code Section 2966 regulates balloon payments secured by Deeds of Trust. The law is not complex: It provides, “In a transaction regulated by this article, which includes a balloon payment note when the term for repayment is for a period in excess of one year, the holder of the note shall, not less than 90 nor more than 150 days before the balloon payment is due, deliver or mail by first class mail, with a certificate of mailing obtained from the United States Postal Service, to the Trustor or his or her successor in interest, at the last known address of such person, a written notice to include….(name and address to whom the balloon payment is required to be made, date of balloon payment, its amount), a description of “Trustor’s right, if any, to refinance the balloon payment, including a summary of the actual terms of the refinancing or an estimate or approximation thereof, to the extent know.”
In short, full notice to any holder of a deed of trust (the borrower or Trustor) of all details as to the balloon payment including any right to refinance. Note that the notice cannot be given too early…it must be made within 150 days of when the due date occurs.
What if the notice is not given? Again, the law is clear. “Failure to provide notice as required by this subdivision does not extinguish any obligation of payment by the Trustor, except that the due date for any balloon payment shall be the date specified in the note or ninety days from the date of delivery or mailing of the notice…whichever date is later. ..if the operation of this section acts to extend the term of any such note, interest shall continue to accrue for the extended term at the contract rate and payments shall continue to be due at any periodic interval and on any scheduled payment schedule specified in the note and shall be credited to principal or interest under the terms of the note. Default in any extended periodic payment shall be considered a default under terms of the note…”
It should also be noted that failure to comply with the above shall NOT effect the rights of any bona fide purchaser of the property in the foreclosure sale. A bona fide purchaser is a person who purchased the property without notice or knowledge of the breach of notice provisions described above.
Notice Requirements on the Note:
Equally important, every note in which a balloon payment notice is required as above must state in writing key provisions of the Civil Code section above. The notice must state the following statements:
This note is subject to Section 2966 of the Civil Code which provides that the holder of this note shall give written notice to the Trustor or his successor in interest of prescribed information at least ninety and not more than one hundred and fifty days before any balloon payment is due.
Again, failure to have said notice does not invalidate the note as a whole but could be used to seek to invalidate an effort to enforce the security.
The rationale behind this particular law was to protect consumers from losing their homes because they did not plan ahead sufficiently to handle the massive balloon payment due. Balloon payments are dangerous methods of borrowing since one does not slowly work down a debt, as with amortized payments, but instead faces a large single payment, sometimes with all accrued interest already due. The Legislature felt that the danger was sufficient to require some advance warning so that the consumer (the Trustor) could prepare and seek to raise the payoff cash.
But note that the remedy is merely to delay the due date by a period of ninety days from when the actual notice is given. While this does allow the borrower time to seek alternative means of payment, the underlying obligation and all its interest continues to exist and interest continues to accrue. The relief afforded is delay, not removal of any obligation.
Further, if a bona fide purchaser obtains the property at the Deed of Trust sale, the borrower has no relief against the new owner. The remedy would to make the buyer not “bona fide” and that means giving notice to the possible buyer before sale of the failure to comply with the balloon payments notice requirements.
If you are the lender, it is vital not only to provide the correct wording in your note, but to calendar your notice deadlines before the balloon payment is due. While the note may be protected by the law, you face more than mere delay since other creditors may be seeking to foreclose on the same property and to have your own sale delayed could imperil your security.