WASHINGTON — A treasure trove? Or Pandora's box?
Those are the contrasting views of the country's largely untapped second-mortgage market that has come into fresh focus this year with the gung-ho entry of the Federal Home Loan Mortgage Corp. (Freddie Mac) into an arena that has long been dominated by individual lending institutions and--for FHA and VA mortgages--by its counterpart, the privately owned Federal National Mortgage Assn. (Fannie Mae).
It's a ripe plum--an estimated $2 trillion to $4 trillion in equity in single-family homes, of which only about $150 billion has been mined.
Fannie Mae, in the past three years has purchased about $3 billion in second mortgages. (And as the name implies, a "second mortgage" is an indebtedness secured by the equity in the borrower's home--the difference between the current market value of the home minus the outstanding balance on the first mortgage. In the event of default, the holder of the first mortgage is paid off before the holder of the second gets his money back.)
Virtually unknown to the average home buyer, the two Washington-based organizations nevertheless largely call the tune on whether any home sale is approved or denied. As the kingpins of the secondary market for all mortgages--both firsts and seconds--local lenders are reluctant to write any sort of mortgage without the built-in assurance that they can turn around and sell the paper to someone who will package it for institutional investors. And, that "someone" is either Fannie Mae or Freddie Mac.
But, until Fannie Mae entered the field three years ago, and Freddie Mac dived in earlier this year, a homeowner wanting to capitalize on the equity in his home, could only hope to find a local lender willing to write a loan and hold it as inventory in his own investment portfolio, or obtain a "home equity" loan, subject to a variable interest rate and fluctuating terms, from a company specializing in these hybrid investments.
As a consequence, Michael F. Coffey, senior vice president for regional operations for Freddie Mac, told The Times in a recent interview in his office here, "There was a definite stigma on the second mortgage, implying excessive risk."
But with Freddie Mac's reputation for conservatism, and with its ability to package (or pool) second mortgages into short-term, high-yielding "Participation Certificates" that are secured by real property, then "you've got the sort of thing you can sell to Wall Street, and that's really the key to the whole thing," Coffey added. And with Freddie Mac prepared to buy second mortgages "anywhere from 25 to 50 basis points (one-fourth to one-half a percentage point) under the interest rate on the first," he continued, an almost immediate decline of about three-tenths of a percentage point in second-mortgage rates is anticipated.
"The seconds currently being offered nationally are in the 11% to 11 1/2% range and, in some areas, as high as 13% to 14%," Coffey said. "And we'll be priced a lot more competitive than that, and the more widespread our own and Fannie Mae's programs become, there should be a positive, downward trend in all rates."
The seconds that Freddie Mac is prepared to buy are fixed-rate, fully amortized loans with original maturities of from five to 15 years, "although experience has shown," he continued, "that regardless of the terms of the second, the average life expectancy of them is about three to four years." There is no penalty for either acceleration or complete prepayment, Coffey added, although Freddie Mac's second mortgages are non-assumable.
In spite of the fact that the seconds that Freddie Mac will buy are fixed-rate mortgages, this doesn't preclude a homeowner from obtaining one even though the underlying first mortgage on his home is an adjustable rate mortgage.
"The only sort of second we won't touch," Coffee said, "is one where the underlying ARM first mortgage has negative amortization. And so that knocks out all graduated payment mortgages, of course, since negative amortization is built into them."
Under the Freddie Mac program, second mortgages will be purchased with loan amounts up to $66,625 on owner-occupied, one-to-four family properties--second homes, vacation homes and investment properties are excluded--which is equal to one-half of the maximum loan amount that the corporation is authorized to purchase on one-unit, single family homes--$133,250.
And, as is the case in the conventional second-mortgage market, generally the maximum financing-to-value is 80%--a ceiling reflecting the combined first and second financing as a percentage of the home's market value. Or, as Coffey said in illustration, a borrower with a home valued at $100,000 and an existing first mortgage of $40,000 would qualify for a second mortgage of $40,000--depending, naturally, on his financial ability to handle both monthly payments, a combined figure not exceeding 33% to 36% of his gross monthly income.