The new renegotiable "rollover" mortgage -- which could begin replacing the traditional long-term home loan this year -- is old hat in for lenders in Canada and a few in New England, Wisconsin and Washington state.
Rollover loans, proposed for unlimited use by all federally chartered S & Ls, are just about the only type of home finance you can get in Canada. Standard there among thrift institutions and commercial banks for more than a decade, Canada's version has some key differences from the plan proposed for the United States by the Federal Home Loan Bank Board.
Home buyers in Canada typically get mortgages that carry five-year terms, but with monthly payments set as if the payback terms were actually 25 years, which keeps the payments low. At the end of the five years, the buyers owe the remaining principal to the lender, but can renegotiate the terms of a new loan to phase in where the old lets off. The new loan may carry a revised interest rate -- up or down by any amount, according to the cost of money in the economy -- as well as a revised payback term.
Buyers are free to shop elsewhere to get better rates or terms, and lenders are free to turn down renewal of loans, if the borrowers haven't performed well or funds aren't available. Lenders almost always renew loans, and buyers stay with their original institutions, but the latitude to do otherwise is there.
Stripped to its essentials, the Canadian "rollover" is a fixed-rate mortgage with a short term. Five years is the most popular term, but many lenders there offer one-year renegotiable mortgages, three-year mortgages and so on. Most loans are assumable -- unlike the United States, where lenders fear the continuation of any low-rate, long-term mortgage -- and the costs of renewal of loans are nominal.
Canadian buyers have accepted the concept enthusiastically, according to lending authorities, because it provides a variety of choice in loans, has kept mortgage rates fractionally below those prevailing in this country, and offers the possibility of an actual rate increase during the course of a typical nine- or 10-year indebtedness.
Lenders in Canada adopted the rollover for the same reason U.S. lenders now want it: the shorter terms make more sense for them in an inflationary period. Rather than having to take a shot in the dark and put a 14 percent rate on a 30-year, $90,000 loan, lenders can charge 12 percent for a five-year, $90,000 loan.
If the cost of money five years hence requires a 17 percent rate -- or a 9 percent rate -- the lender at least knows he's going to get a chance at changing his price at a foreseeable point down the road. He doesn't have to charge new borrowers a premium on their rates in order to make up for the big losses he's taking on the low-rate, long-term mortgages in his portfolio.
The American version of the rollover has some important differences when compared with the Canadian, however. As proposed by the bank board, the regulatory agency for federally chartered S & Ls, U.S. lenders would offer borrowers long-term mortgages -- up to 30 years -- with predefined rate renegotiation periods during the loan.
Rather than signing up for a three-year or five-year loan, as a borrower would in Canada, the American buyer would sign up for a guaranteed term, with agreed-upon changes at three, four or five-year intervals. The monthly payments to the lender might be the same as in the Canadian plan, but the U.S. borrower would have a long-term commitment.
The lender couldn't demand to be paid in full at the end of any interval, as lenders can do on Canadian rollovers, but would have to retain the loan as long as the borrower accepted the renegotiated interest rate. (The bank board's use of the word "renegotiation" is euphemistic: the lender could effectively dictate the revised rate, and the borrower would have the choice of taking it or going elsewhere.)
Lenders would have to justify their rate according to one of two nationally uniform methods, and could never increase rates more than 1/2 a percentage point per year or 5 percentage points during the course of a mortgage. If rates fell, they would be obliged to pass on the decreases at the renegotiation intervals.
Consumers would have time to shop around prior to their multi-year rate adjustments, and could shift to an institution with better terms or rates, just as in Canada. The costs of closing out the initial mortgage, however, and of getting a new commitment are likely to keep this sort of switching to a minimum.
The U.S. plan contains two key safeguards that the Canadian rollover doesn't: a long-term guarantee and a lid on rates. But stripped to its essence, it is a variable rate mortgage, and consumer advocates on Capitol Hill and elsewhere in the United States have never favored this device.
Sen. William Proxmire (D-Wis.), who heads the Senate Banking, Housing and Urban Affairs Committee, has been an outspoken opponent of the variable rate idea for years. He opposed the Federal Home Loan Bank Board's variable rate regulations -- which permit increases of up to 2 1/2 percentage points during the term of a loan -- and may well dissent on the rollover, which allows 5 percentage point increases.
He is also likely to criticize the bank board for permitting S & Ls to offer only renegotiable mortgages and do away with the traditional fixed rate, long-term loans. The existing variable rate regulations prohibit lenders from offering such loans unless they also allow consumers the opportunity to have a fixed rate plan.
Proxmire and others are studying the proposed regulations over the congressional recess, and should make their initial comments on them later this month. It's doubtful, though, that Congress will try to block the regulations or that the bank board will have to make wholesale changes in the proposal before unveiling the program in final form this spring. The U.S. variant of the rollover mortgage is here to stay.