One of the fastest-growing techniques for creative financing of homes in today's tough market -- the wraparound loan -- is about to come under sharp attack by the nation's largest owner of home mortgages.
Fannie Mae, the Federal National Mortgage Association, is serving notice that it's not going to sit by passively while local bankers, home sellers and buyers make millions off its stock of low-rate loans.
Fannie Mae -- which owns nearly $60 billion worth of U.S. mortgages -- plans to blow the whistle on any home sale in the United States that involves professional wraparound financing on one of its conventional mortgages.
That may sound like a mouthful, but it boils down to this: If you're the buyer, seller or sales broker of a house with a 6 to 11 percent loan on it, make sure it's not owned by Fannie Mae before you do anything creative.
If Fannie does own the mortgage, and the loan is neither FHA or VA, don't use the popular wraparound technique -- or else the entire transaction could get very expensive.
The wraparound, which until the late 1970s was considered an exotic financing device limited to commercial real estate transactions, has turned into a bread-and-butter solution for tens of thousands of real estate brokers and homeowners in 1980-81.
It involves three elements. First, a house with an existing, long-term mortgage carrying an attractively low interest rate. Second, a buyer who can't afford the 15 to 16 percent interest rates required for a new mortgage, or who can't come up with the cash necessary to assume (take over) the low-rate mortgage. And third, a lender with cash to help both buyer and seller.
The key to any wraparound transaction is turning the old, low-rate mortgage on the home into a financial milk cow -- and preserving its bargain, low monthly payments indefinitely.
The wraparound lender does this by writing a new mortgage on the house large enough to encompass -- literally wrap around -- both the principal debt on the old loan, plus most of the sales price above that amount.
To illustrate, let's say a house is for sale at $100,000 and has a $45,000 mortgage at 8 percent on it. The young couple who wants to buy the house can scrape together $20,000 for a down payment, but can't come up with the $55,000 down payment necessary to assume the 8 percent mortgage. Nor can they afford the $1,053 monthly payments required for a new $80,000 mortgage at 15 percent.
However, a wraparound lender, such as a savings and loan association (S&L) or bank, could advance the couple the $35,000 in cash necessary to qualify for the assumption. (The couple's $20,000 plus the new lender's $35,000 equals the seller's $55,000 equity.)
But instead of simply writing a $35,000 loan, the lender writes an $80,000 mortgage -- large enough to encompass the existing $45,000 debt plus the $35,000 cash. The $80,000 loan carries a 12 percent rate, 3 points below the market, and a $823-per-month payment that the couple can afford.
The wraparound lender ends up pocketing the 4-percentage-point "spread" on the 8 percent owed to the original lender for the $45,000 loan, and gets 12 percent on the $35,000 it actually loaned to the buyers. The true dollar-on-dollar yield to the wraparound lender ends up in the 17 to 18 percent range -- better than it could have obtained by making a regular mortgage.
The buyers are happy. The wraparound lender is happy. Brokers, sellers, title companies, lawyers and mortgage insurers are all happy.
The only one unhappy is the poor owner of that 8 percent, fixed-payment mortgage that has another 20 to 25 years of red ink yet to run. It is now "wrapped" tight for the ages, with little likelihood of early payoff.
By far the most unhappy owner of low-rate, assumable mortgages in the United States is Fannie Mae. It has upwards of $18 billion of conventional home loans in its portfolio, and finds that many of them are in the process of being wrapped by local S&Ls and banks.
"We're not being raped, we're being wrapped!" exclaims Fannie Mae chairman Oakley Hunter. "But now we're going to take defensive measures."
Defensive measure number one will be to exercise its legal right -- contained in the fine print of every non-FHA or VA mortgage Fannie owns -- to demand immediate, full payment of principal on any loan being transferred. Hunter says Fannie Mae will do this on any loan that is wrapped by another lender.
Defensive measure number two will be to offer carrots to sellers and buyers to dissuade them from participating in wraps. Fannie Mae plans to announce details shortly about a new program of below-market-rate second mortgages (for buyers) and refinancings (for owners). Both programs will be aimed at encouraging owners of properties with low-rate Fannie Mae mortgages to trade them in for newer, larger loans with advantageous terms.
By the way, most owners of homes whose mortgages are owned by Fannie Mae don't know it. So call your local lender to find out . . . and don't fool with Fannie.