Mortgage burning--that questionable rite for people who've finally paid off their loans and own their homes--sounds prehistoric to American home buyers schooled in the inflationary 1970s and '80s.
But Merrill Lynch, the biggest and most bullish investment house on Wall Street, wants to revive the quaint, old custom in a sophisticated way.
Within the next two months, Merrill Lynch will begin market tests of what it has dubbed the "growing-equity mortgage." Affiliated real estate brokers and lenders will offer home buyers a new form of loan--one that carries a below-market fixed rate, a 30-year maximum term, and the ability to pay itself off in 10 to 11 years.
The monthly mortgage payments will be fixed for the first year, based on an interest rate pegged 2 to 3 points below the prevailing conventional market rate.
At the end of the first year, the payment schedule will be revised according to a Commerce Department index of per capita disposable (after-tax) income. If the index has gone up by 10 percent during the year, the monthly payment will be raised by 75 percent of that--7 1/2 percent. If the index stayed flat or rose only slightly--as it would in a severe recession--the monthly payment would barely be touched.
Future monthly payments would be revised once every 12 months, always tied to 75 percent of the national index of disposable income.
So far, you may be thinking, this sounds like just another form of adjustable or variable mortgage. It's no great bargain. And you're right, except for one significant difference:
Under the "growing-equity" concept, every cent of additional monthly payment the borrower has to contribute beyond the initial monthly amount is devoted to reduction of the principal debt. The extra payments, in other words, aren't thrown away as interest, as they'd be in a standard adjustable-rate or variable-rate mortgage.
The increases go straight into equity build-up, thereby cutting the length of time it ultimately will take to pay off your debt. A growing equity-loan payment rising at just 7 percent a year, according to a Merrill Lynch economist, would pay itself off completely in less than 11 years.
To illustrate the difference, let's say you borrowed $70,000 for a new home two years ago using a 13 percent adjustable-rate loan from a bank. Let's say also that the loan was tied to an economic index that made your effective rate 18 percent six years from now. Your monthly payment under that loan would have gone from $774 at the start to $1,055 in 1987.
More to the point, though, your principal balance at the end of the first eight years would still be close to your original debt, about $67,000.
Compare what would have occurred had you borrowed via an indexed growing-equity loan under the same set of hypothetical inflation assumptions. Your monthly payment at the end of eight years would be roughly the same as the adjustable-rate loan. But your remaining debt to the lender would be about half of the original amount--under $37,000.
Six years from now, in other words, you'd be halfway out of debt with the growing-equity loan. You'd have a higher net worth, and be in a far stronger position to refinance the loan and switch to lower monthly payments.
With the standard adjustable-rate plan--front-end loaded with interest--you'd be in worse shape. You'd still have a big debt hanging over you, and little to show in equity accumulation. If annual price inflation in housing was low during those years, you'd hardly have improved your capital position.
For its part, Merrill Lynch likes the concept so much that it hopes to package thousands of locally originated growing-equity loans in the coming months and sell them as securities to pension funds and life-insurance companies. Other capital-market giants with real estate connections may jump in with modified versions of Merrill Lynch's plan, making the growing-equity loan a major new force on the home-mortgage scene.
But is it really all that it's cracked up to be?
It's still to early to evaluate the concept in depth from a consumer point of view, but it has at least a few potential drawbacks for borrowers.
The national index it's tied to, for instance, may measure per capita disposable income growth, but that's a poor gauge of regional differences in income patterns. Despite a deep recession and high unemployment in the Midwest since 1978, for example, Commerce's disposable-income index has jumped by 35 percent. An unemployed autoworker in Detroit might have found it tough to keep up with the national standard during the past two years.
Also, the growing-equity plan cuts down progressively on tax deductions for interest payments--a key to housing affordability for many Americans, even in the Reagan era of modest tax-bracket breaks.