The season's spirit of creativity has hit the Federal Home Loan Bank Board, which wants mortgage lenders across the United States in 1981 to write tens of thousands of "wraparound" loans with no worries about running afoul of state laws.
In a move that could have major significance for home buyers and sellers in the new year, the bank board had proposed to override all state usury limits on wraparound financing.
Wraparounds -- once used almost exclusively in commercial real estate -- are increasingly attractive and common in residential transactions in today's tough market. They often carry interest rates that are 2 to 3 percentage points lower than market rates, and they always cut the size of the down payments required from buyers.
Wraparound loans sound more complex than they really are. When a home for sale carries a lower-rate assumable mortgage but a high price, the prospective buyer is forced to come up with a hefty down payment.
A lender could assist such a buyer, though, by providing a new loan large enough to encompass the existing mortgage, plus cover most of the remainder of the home price. The new loan would literally wrap around the old loan, and extend additional funds to the buyer.
For example, let's say you want to buy an $80,000 town house that currently has and 8 1/2 percent FHA or VA assumable first deed of trust of $25,000. To take over that loan and step into the shoes of the home's current owner, you'd have to come up with $55,000.
Since you can't produce that sort of cash and the seller chooses not to help you by taking back a second trust, you're frozen out of the purchase.
Unless, that is, you can find an outside lender -- like a bank, savinsg and loan, mortgage lender, or private investor -- who would agree to provide you a wraparound loan (or an "all inclusive deed of trust," as it's popularly known in California.)
The wraparound could work like this: The new lender would extend you a loan of $70,000 at 12 3/4 percent interest with a 20-year payback period, the same as the remaining term on the FHA-VA loan.
You'd make a down payment of $10,000, and would assume the existing $25,000 loan. Your monthly $807.68 principal and interest payments on the $70,000 loan at 12 3/4 percent would partially go to the new lender to cover the $201.31 per month due on the assumed, old 8 1/2 percent loan.
The new lender, however, would actually be making extra money on your payments at 12 3/4 percent -- pocketing the 4 1/4 percent "spread" or profit on the $25,000 existing debt.
You'd have a new house with 10 percent down and 12 3/4 percent interest and your lender would have a higher effective yield on his money than he'd get by trying to lend it out to a buyer at today's market rates.
The problem with wraparound financing -- and a key reason why only about 100 savings and loan associations around the United States have tried it -- has been state usury laws.
Wraparounds are considered second liens or mortgages in most states, and they are subject to usury limits ranging from 12 to 18 percent. The federal government has pre-empted state usury limits on first mortgages and deeds of trust, but not on second loans. Usury limits can be calculated as the yield to the lender on the funds actually advanced to a borrower -- which is higher on a wraparound loan than the interest rate on the note.
Rather than risk charges of usurious lending practices, S&Ls and banks have tended to avoid involvement with wraparounds altogether.
The Federal Home Loan Bank Board, however -- using the new financial institutions deregulation law passed by Congress this session -- is proposing to redefine wraparounds as having the "effect" of first liens, thereby sidestepping state restrictions.
The board intends to make the exemption final in February, after a 60-day formal comment period.
If it goes ahead with its plan, as expected, the usury exemption will apply to wraparounds provided to home buyers by private individuals (such as home sellers), S&Ls, banks, and most professional lenders.
Wraparounds won't solve everybody's home-buying or selling problems. But widespread use of them by lenders will be an important advance for creative real estate financing.