The Comptroller of the Currency this week proposed that national banks be allowed to make mortgage loans on which the interest rate could be raised by 1/2 percent every six months -- twice as much as savings and loan associations are allowed to raise theirs.
The comptroller's office is proposing to add the adjustable rate mortgage (ARM) to what has become an alphabet soup of non-fixed-rate mortgages. The adjustable rate mortgage combines some of the features of both the variable and renegotiable rate mortgages now offered by thrift institutions.
All the mortgage plans work on the same principal -- the interest rate and resulting monthly payments may be changed at fixed intervals according to an index -- but the adjustable rate mortgage has certain differences.
The adjustable rate can be raised 1/2 percent every six months, while the renegotiable rate cannot be raised more than the equivalent of 1/2 percent annually for each year of the three- to five-year contract period.
The initial period (during which the rate remains fixed) on an adjustable rate may be negotiated by the lending bank at anywhere from six months upward. (The maximum amount the rate on an ARM can be lowered is also 5 percentage points during the contract period, although the decreases may be made at the lender's discretion.)
While the Federal Home Loan Bank Board has limited the total increase in the interest rate on a variable rate mortgage to 2 1/2 percent over the 30-year life of the loan and to 5 percent on the renegotiable rate mortgage, the comptroller's office has not yet decided on a cap.
It has put out three options for comment: a 5 percent cap, no limit whatsoever, or a 50 percent increase. Under the third option, a mortgage that was initially contracted for 12 percent could go up a maximum of 6 points to 18 percent.
Another difference in the adjustable mortgage is that negative amortization would be permitted. To the home buyer this formidable term means that the mortgage principal or the amount owed on the house can actually increase while payments are being made if interest rates go up.
At the moment investors are wary of buying mortgages with these provisions so lenders are loathe to make such loans. The proposal seeks to soften the effect by not allowing the amount of extra principal to exceed 5 percent over five years.
The earliest the ARM plan could go into effect would be the end of the year.
The comptroller's office gave a "worst case" example of negative amortization: A $50,000 mortgage is issued at 10 percent. If market interest rates continue to rise an average of 1/2 percent every six months, by the end of nearly four years (46 months) the borrower would owe $52,439. After five years the homeowner would owe the lender $55,000.
However, because the amount of added principal would be limited to 5 percent of $50,000 or $2,500, the borrower would find his or her mortgage rate adjusted on a principal of $52,500. The lender would absorb the other $2,500.
Finally, the proposal would preempt state law and make adjustable rate mortgages assumable at the bank's discretion and at any rate not above that charged on new ARMs. In practice, said a spokesman, banks usually adjust the rate on an assumed mortgage upward about halfway between the old and new rates.
The comptroller's office said the proposal is aimed at giving banks flexibility in lending, while the Federal Home Loan Bank Board has come out against savings and loans allowing mortgages to be assumed.
In another action this week, the Federal National Mortgage Association notified lenders that it would not enforce its new policy against buying assumable mortgages, scheduled to go into effect Oct. 1, because a number of states permit these assumptions.
Fannie Mae had intended to stop buying mortgages that could be assumed because prolonging the life of low-interest mortgages in times of rising interest rates cuts into its profits.
However, as the result of several court cases and consumer protests, 11 states have legalized assumption by prohibiting lenders from including "due-on-sale" clauses in mortgage contracts. (Such a clause means the balance of the mortgage is due when the house is sold and a new buyer may not continue to pay off the old mortgage.)
This week Fannie Mae said it would delay enforcement of due-on-sale clauses until some unspecified date. Meanwhile, a spokesman said, it will consider whether to put a surcharge on assumable mortgages or allow a lender to call them due after a certain number of years.