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4000 - Advisory Opinions
Regulation O: Wrap-Around Mortgage Transactions
FDIC-80-4
February 15, 1980
Pamela E. F. LeCren, Attorney
The following is in response to your request that this office assess
the practice of granting "wrap-around" mortgages within the
context of Federal Reserve Regulation O (12 C.F.R. Part 215). The
question was initially posed to you by ***.
A "wrap-around" transaction typically takes the following
form. A borrower who has an outstanding mortgage wishes to refinance
the mortgaged property without disturbing the existing loan which may
be at an interest rate much lower than currently available. The
borrower obtains a mortgage from a second institution (the
"wrap-around" lender) in an amount that equals the sum of the
outstanding mortgage at the first institution and the new
money sought with interest calculated on the total figure at an
interest rate below current market rates. The borrower does not receive
funds equal to the full wrap-around mortgage, but rather the difference
between the full mortgage and the outstanding debt to the first
institution. The "wrap-around" lender collects payments from the
borrower based on the full mortgage, passes through to the initial
lender an amount equal to the debt service on the first loan and
retains the remainder. In this manner the initial mortgage is repaid
according to its outstanding terms and the "wrap-around" lender
obtains a return on the new funds extended that is higher than the
stated interest rate of the wrap-around mortgage.
Before turning to the question of how to assess this practice under
Regulation O, it should be noted that the practice itself is one that
should be carefully reviewed outside of any Regulation O context. Since
the wrap-around mortgage is essentially a second mortgage, and
therefore an inferior lien, it may be a questionable investment for the
bank to engage in and one that has little advantage if any for the
bank. If there is any advantage gained from extending a wrap-around
mortgage, it may well be unlawful. There is a real danger that the
practice may be used as a mechanism to obtain a higher return than
permitted under state usury laws.
Assuming in any particular instance that the practice does not
result in a usury violation and that the investment in the second
mortgage is not otherwise
questionable, 1
the
{{4-28-89 p.4039}}extension of a wrap-around mortgage to
an insider of the lending institution may or may not present problems
under Regulation O. Initially, let us state that only the new money
extended by the wrap-around lender would be counted against the
insider's loan ceiling under Regulation O. We would also look to the
actual return on the new money in order to judge whether or not the
extension was preferential and not the interest rate as stated in the
terms of the note itself. (If we looked to the stated terms, the
transaction would be preferential in all cases as the interest rate is
below current interest rates.) If the actual return is not the same or
substantially the same as the bank obtains on a second
mortgage 2
extended to persons not associated with the bank who are equally as
credit worthy, then the transaction would be preferential and
constitute a violation of section 215.4(a) of Regulation O. Even if the
return is the same or substantially the same, the transaction may be
preferential if the bank has not extended, and does not anticipate
extending, wrap-around mortgages to persons not associated with the
bank. 3
We are unable to determine whether or not the particular wrap-around
mortgage *** is contemplating is preferential under Regulation O as we
do not have sufficient facts at this
time.
1 According to *** inquiry, the bank's accounting records would
show a participation to the initial lender in the amount of the
outstanding balance on that loan when no such participation actually
occurred. This may or may not be proper accounting procedure. Go Back to Text
2 If the wrap-around mortgage is accorded first lien status
under state law or by the state banking authorities, then the interest
rate would be compared to interest rates obtained on first mortgages. Go Back to Text
3 It is our understanding that structuring the second mortgage
in the form of a wrap-around loan is advantageous to the borrower in
that the monthly debt service on the wrap-around loan is less than the
debt service that would otherwise be paid if two schedules were being
independently serviced. Go Back to Text
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