The Federal Home Loan Bank Board yesterday proposed a new form of residential mortgage whose interest rate can be adjusted every three to five years to reflect market conditions.
If approved, the renegotiated or rollover mortgage could eventually signal the end of the fixed-rate mortgage, the American homeowner's primary hedge against inflation.
According to Jay Janis, bank board chairman, the traditional long-term, fixed-rate mortgage "just won't work" in today's economy.
The move is intended to give savings and loan associations, the major provider of mortgage funds, more flexibility to pay higher interest rates on desposits. The industry had warned that mortgage money would dry up if thrift institutions continued to carry fixed rate loans in their portfolios while paying market rates on money market certificates.
Edwin B. Brooks Jr., president of the U.S. League of Savings Associations, yesterday hailed the action, saying, "It will help solve the feast and famine cyclical problem that has plagued the savings and loan industry for years." The National Association of Mutual Savings Banks called it "timely and necessary."
The initial interest rate on the new mortgage would remain constant until it is renegotiated between three and five years later. (The intervals, which are decided when the mortgage is granted, remain the same throughout the life of the mortgage.) At any renewable period, the maximum increase would be 1.5 to 2.5 percentage points, depending on changes in market rates or an index of loan rates. Over the life of the mortgage, the rate could be raised or lowered a maximum of 5 points. Refinancing is guaranteed if the payments have been kept up.
For example, if the mortgage were originated at 13 percent, theoretically, the rate could go as high as 18 percent or as low as 8 percent. A typical renegotiation schedule might work as follows. In the first year interest rate on a given mortgage is 9 percent, rising to 10 percent three years later, 12 percent in the sixth year, and 13 percent in the ninth year. During the same period market rates rise 9 percent in year one, 10 percent in year three, but rise to 15 percent in year six and drop to 14 percent in year nine. The borrower, according to the bank board, would thus be ahead of the game.
The renegotiated mortgage is similar to the variable rate mortgage which the bank board authorized earlier this year. But there are important differences. First, the limit on how much the rate can vary has been doubled from 2.5 to 5 percentage points. Second, the lender is not obliged to offer the borrower the option of a fixed-rate mortgage if he or she wishes it. Thrifts are more enthusiastic about the roll-over than the variable rate mortgage for these reasons.
The advantages to a borrower, especially at a time when interest rates are believed to have peaked, is that he or she will not be locked into a 30 year mortgage at a high rate. If, however, interest rates continue to rise, the borrower does not have the inflation hedge of a fixed rate. Also, it is expected that lenders will offer discounts of perhaps one half of one percentage point over conventional mortgage rates to induce new borrowers to accept the new type of mortgage.
The experience of two savings and loans associations in offering the roll-over mortgage shows considerable customer acceptance. Capital Federal Savings & Loan of Olympia, Wash. has been offering them for five years. Now almost half of its mortgages are of the new type.
According to T. H. Wolfe, "A five year rollover is ideal for young executives or military personnel who know they will be moving within five years. They get a one quarter percentage point discount, the rate remains constant for five years, there is no prepayment penalty clause, and the mortgage is assumable. Those who intend to stay longer choose the standard fixed-rate mortgage."
But in Wisconsin, where the standard mortgage is rare, Dick Larson of West Bend Savings & Loan notes that there is widespread acceptance even without a discount. "People like rollovers better when they preceive interest rates as high. Forty percent of our new applications last summer were for this type of mortgage."