Courtney Harbaugh, the lovely and awesome Associate Attorney with Diane Wanger (www.familylawtex.com), asked this very insightful question. Check out their website. They are legendary in DFW Texas Family Law.
“I know that you were working with [client] on his potential Owelty loan. I just wanted to know, for my own understanding, why one would do a second mortgage instead of an owelty on the first mortgage? I was curious! Thanks! :)”
This client who had been referred to me for financing chose to obtain financing for the buyout (using an Owelty lien) with a second lien only rather than refinancing the first lien and including – in that new first lien – the Owelty. As an aside, these are transactions I refer to a second lien company and do not do them myself.
Courtney and Diane thought my response merited a blog. Thus…my answer published here.
When a grantee is financing, their consideration (understandably so) is to get favorable financing. If the spouse is not on the first mortgage (which is being assigned as a debt commensurate with the awarding of the property), there is no external reason to refinance that mortgage. In other words, wife (in this case) does not have the mortgage on her credit as a credit obligation and therefore has no logical basis to require her spouse to refinance it. Therefore, if the existing first mortgage is at a relatively good interest rate, the grantee/borrower may not wish to refinance to a similar or even higher rate….what’s the point, if you know what I mean.
Thus, the only concern for the grantee is to produce money for the buyout. An Owelty lien can be financed (using the right companies…ones which understand that Owelties do not require Texas Home Equity financing, etc.) as a second lien behind the existing 1st mortgage. The rates are higher for second liens and the terms usually tighter (like 15 year terms…but occasionally, they stretch them out to 30 with a premium added to the rate). But still, a homeowner might determine that the numbers in their case are more favorable by paying a slightly higher rate on just the buyout portion and leaving the existing mortgage alone.
I might add that another motivation for a homeowner (grantee) to use only a second lien to finance the Owelty is that, even though the total monthly payments may be higher, the borrower may have the wherewithal to pay this second lien off in short order, leaving him or her with only the lower balance of the first mortgage to pay. Depending on the numbers, it could be more a psychological consideration than a mathematical one.
Or, as Yogi Berra said “Baseball is ninety percent mental
and the other half is physical.”
The fact is, the same effect (of lowering the total monthly payment) could be attained by a little known process called “recasting.” When a homeowner pays a large amount (usually $10,000 or more) against their mortgage, they can request that the lender “recast” their mortgage amortization so as to be paid off in the same amount of time but against a smaller balance. This lowers the monthly payment without changing the terms of the note/contract.
The main thing to keep in mind is that Owelties are financeable at rates and terms of regular mortgages. This is what makes them “affordable” in the sense of monthly payments. Up to 30 year amortization at the lowest market rates. As well, Owelties are NOT “cash outs” or “Texas Home Equities.” They are standard, “purchase money” or “rate and term” mortgage loans.
Hope this helps. Thanks for reading.