Homeowners across the country are pulling hundreds of millions of dollars out of their homes for consumer and investment purposes. They are using the fastest-growing and least-regulated real estate financing tool: second mortgages.
Pressed by an economy that has held the rate of family income growth below the rate of inflation, households have turned to be the one capital resource that has outpaced all the price indexes, their own dwellings.
Families traditionally have turned to short-term personal bank loans to help finance their children's college educations or down payments on vacation houses. New money sources for many of these families now are the rapidly proliferating firms that offer second deeds of trust and mortgages. The firms place 15-year new loans on top of borrowers' existing mortgages.
Business owners or investors who would have borrowed capital from their commercial banks to acquire equipment or purchase rental real estate now put part of the inflated equity in their houses up as security, and walk away with long-term financing.
Demand for these equity loans, particularly in an area with high incomes and high housing costs such as Washington, has been so intense in the past 18 months that a significant percentage of the money being loaned to local second-mortgage borrowers now has to be imported by lenders from other sections of the U.S.
Symbolic of this trend was the establishment last year of a subsidiary of a huge New Jersey savings and loan association in suburban Fairfax.
Its sole function is supplying equity loan dollars to the hot Northern Virginia market. The subsidiary, known as City Consumer Services Inc., was the first out-of-state equity loan office ever set up in the country by a federally chartered thrift institution, according to the U.S. League of Savings Associations.
The parent institution, 200 miles to the north, is Federal Savings and Loan of Elizabeth, N.J., which has assets of $1.8 billion, City Federal is the 31st largest S&L in the country. Through its experimental equity loan branch in Fairfax, City Federal has been able to export its own deposit capital at returns of 14 to 16 percent -- well beyond what it could get with equivalent safety in the slower-moving housing market of northern New Jersey.
A City Federal Spokesman said the Fairfax office generates "about $1 million a month" in new loans, and has done so well that City Federal has opened five more offices patterned after it in Jacksonville, Fla., Denver, and three towns in Connecticut.
Maryland's new 16 percent usury ceiling on second deeds of trust and mortgages, which has more than doubled the number of real estate equity loan companies operating in the Washington and Baltimore suburbs in the past 90 days, also has caught City Federal's eye, the spokesman said. The S&L is now looking at new equity loan branches for Bethesda and Rockville, bringing New Jersey export dollars to Montgomery County borrowers.
The mechanics of equity loans vary somewhat among the dozens of active lenders here, but City Consumer's basic terms and costs give an idea of how this form of financing works.
For most applications for loans of up to $30,000, City Consumer multiplies the appraised market value of an owner-occupied home in Northern Virginia by 80 percent, and then subtracts the existing mortgage debt, to get its own maximum amount for a second deed of trust.
For example, if a family owned a house worth $90,000, with a $47,000 first trust and could handle the additional monthly payments. City Consumer would consider providing a $25,000 second trust. (The math: $90,000 times .80 minus $72,000. Subtract the $47,000 existing mortgage and you get $25,000.)
The proceeds of the loan would have to go for business-related or investment purposes, rather than consumer purchases, but the range of uses is extremely wide, from buying gold to antique collectibles to rental townhouses.
Loan applications of $30,000 to $100,000 have to pass a more stringent standard. The lender multiplies the appraised value by 70 percent before subtracting the existing first trust debt, thereby giving it a thicker security cushion against appraisal errors or unexpected property value decreases, should a foreclosure sale ever be necessary.
City Consumer's rates and charges on the $25,000 loan would go as follows: For a 15-year second trust, the flat interest rate would be 16 percent. There is a 2 percent "service charge" -- the functional equivalent of two "points" on the loan or $500 or prepaid interest -- which can be added into the principal and financed over 15 years, paid out of pocket at settlement, or deducted from the loan proceeds.
At settlement the borrower also has to come up with $100 for City Consumer's attorneys' fees, $45 for the appraisal fee, and $60 for recordation charges. The monthly payments on the loan would be $367.18.
Until the recent, record jumps in the prime lending rate, City Federal's Virginia subsidiary also made loans for consumer purposes, ranging from furniture purchases to Caribbean cruises. Virginia's 12 percent usury ceiling on consumer-purpose loans, however, has knocked the firm out of that segment of the market until the state legislatures raises the limit, as Maryland did this summer under industry and consumer pressure.
Next Week: The risks of second loans, and their impact on inflation.