Underlying Mortgage Overview
An underlying mortgage is an original loan taken out by a housing cooperative to finance the purchase of the land or building that it occupies. This term may also be known as a “blanket loan,” “blanket mortgage” or “blanket debt.” Although it may also be used to describe both the initial loan in a wraparound mortgage agreement and one of the pieces of debt that comprise mortgage-backed security, it is most commonly used in relation to the housing-cooperative market.
A cooperative’s underlying mortgage payments may swallow a substantial amount of its members’ monthly fees. Although co-op arrangements vary widely, members often subsidize the cost of their association’s underlying mortgage even when they are responsible for a separate mortgage on their individual unit. Once the obligation has been paid off, their membership duties may drop significantly.
In fact, underlying mortgages represent a principal source of income for struggling housing cooperatives. In recent years, a robust secondary market for these products has made it increasingly easy to refinance them. Co-ops may also refinance their underlying mortgages to pay for major expansion or upkeep projects and to take advantage of lower interest rates.
Underlying Mortgage: What You Need to Know
Underlying mortgages can be sourced through one of two principal sources:
- Primary Lenders (commercial banks)
- Secondary Lenders (Pension funds, government-run lenders of last resort, investment banks, or other none retail financial firms)
While co-ops have traditionally turned to primary lenders for support, the secondary market has become increasingly viable thanks to persistently low rates and lax financial regulations.
Since co-ops tend to have access to deeper pools of funding, underlying mortgages with terms as short as five to seven years are not uncommon. They become especially prevalent when interest rates fall. A building association that elects to secure short-term financing for its property may pass this cost onto its members. However, to prevent dues from becoming prohibitive, it may spread the full cost of the mortgage over a longer period of time. This has the added effect of reducing the financial burden on charter members and affording new members a stake in the property.
In addition to the advantages associated with their refinancing, underlying mortgages may provide co-op residents with a surprising tax benefit. If they can prove that their monthly dues are used to cover payments on the co-op’s land or building, they can use the interest on the mortgage-related portion of those dues as a tax write-off.
On the other hand, underlying mortgages pose significant risks to co-op members. If the association’s board elects to take out an adjustable rate or a balloon mortgage, it may set up the co-op for disaster in the event of an unexpected interest-rate spike. In addition to losing their equity share in the underlying property, shareholders evicted from their co-op due to bank foreclosure or a bankruptcy filing on the part of the association will remain responsible for paying off the secondary mortgage on their former unit.