Mortgage Hodgepodge: Wraparounds and More

With today’s post, I’d like to do something a bit unconventional by focusing on a few (perhaps unrelated) topics that don’t each merit an entire article. Specifically, I’ll outline a wraparound mortgage, before touching upon the trend towards 15-year mortgages, and conclude by explaining how decreased competition is making mortgages more expensive.

Most of you have probably never heard of a wraparound mortgage, and for good reason. They are incredibly risky and not very common. But before I get ahead of myself, let me first back up and explain what exactly is meant by the term. Simply, a wraparound mortgage is used to describe a scenario in which a home-seller offers a mortgage directly to the home-buyer, the monthly payments from which are used to pay down an existing first mortgage.

If you’re scratching your head, consider a more concrete example. Let’s pretend that you have an outstanding mortgage on the house you just sold. With a wraparound mortgage, you would collect mortgage payments from the home-buyer, which would be used to pay down your initial mortgage, and you would earn the spread between the rate that you pay and the necessarily higher rate that you collect.

How would you ever find yourself involved in such a byzantine scenario? It’s possible that given the current desperate housing market, a buyer would be forced to offer a special arrangement to a (un-creditworthy) seller in order to close the deal. This is pretty unlikely (and not recommended) as wraparound mortgages only make sense when interest rates are rising rapidly, in which case the interest rate on the original owner’s mortgage could be significantly lower than a rate that even the most creditworthy homebuyer could hope to secure. In such a situation, a wraparound mortgage would be beneficial for both parties. In the current interest rate environment, it’s not likely that this kind of deal would ever be worthwhile for the seller, who must ensure the timeliness of mortgage payments and could even find himself having to foreclose on the property if the buyer became “delinquent.” That’s what banks are for…

Shifting gears slightly, let’s look at the surge in popularity in 15-year fixed rate mortgages. 15-year rates have fallen even faster than 30-year rates; even adjusting for the recent uptick, they are still close to a record low. [Chart courtesy of NY Times].

You may recall from an earlier post (”Refinancing: Fees/Taxes Versus Interest Rate Savings“) or from other articles you have read about refinancing, that it can sometimes be difficult to make the math work. One nearly surefire way to guarantee savings is if you refinance into a 15-year mortgage.

The problem is that these savings are condensed into a shorter time period, which means while you’re overall savings are often tremendous, your monthly payments may actually increase. Accordingly, some experts recommend that you simply refinance into another 30-year mortgage, and use any extra cash (that you would have otherwise would have spent on higher 15-year monthly payments) and use it to pay down your mortgage early.

Finally, consider that the consolidation in financial services as a result of the credit crunch means that three banks (JPMorgan Chase, Wells Fargo and Bank of America) now dominate the mortgage market. “After buying out a raft of distressed rivals, the big three now account for the lion’s share of U.S. mortgage originations. They also service about half of U.S. home loans, mailing out and collecting mortgage payments even for loans they did not originate.” For this reason, it’s important to do your homework when shopping for a mortgage to make sure that less competition doesn’t inherently translate into a worse mortgage!