Moderate declines in mortgage rates have speeded up an important shift in the national home real estate market during the past several weeks: Consumers, lenders and investors are moving to fixed-rate loans, some of them with intriguing new-fangled, money-saving features in the first years of the loan.
Characteristic of the emerging trend is a fast-selling 30-year mortgage plan that some home builders and local lenders will begin offering the public early in December.
Dubbed the "HOWE" mortgage (for homeownership with ease), it racked up more than $400 million in loan commitments in its first week of offerings to the industry. That's a torrid pace for any new financial product.
The HOWE plan works like this:
*Home buyers qualify for loans up to 95 percent of the value of the house at initial rates 3 to 4 percentage points below the going market charges for fixed-rate loans. Typical first-year rates quoted in late November were between 9 3/4 and 10 1/2 percent.
*During the next two to three years, the rate moves up by 1 or 2 percentage points a year until it reaches the "contract" note rate. The contract rate is pegged 1 to 1 1/4 percent above the Federal Home Loan Mortgage Corp. quotation for long-term, fixed-rate mortgages at the date of closing.
*The usual heavy dose of up-front expenses associated with "buy-downs" or builders' rate subsidies of fixed-rate loans is eliminated. Rather than 8 to 10 points being tacked on to the sale price of a newly constructed house, the HOWE concept is intended either to reduce initial sales prices or permit builders to offer more amenities without raising the sales price. (A point is equal to 1 percent of the mortgage amount and normally is paid in cash at closing or incorporated into the house price.)
Fixed rates, lower sale prices, more amenities plus discounts in the early years of a mortgage? Where's the catch? you ask. Or is HOWE some new form of mortgage-market alchemy?
The catch is simple: The alchemy is in the computer program that produced the payment and rate schedules. To understand it, consider the advertisements you see every weekend for new homes featuring fixed-rate loans with initial rates in the 8 to 11 percent range.
These are virtually all builder buy-downs. As an inducement for purchase, the homebuilder has secured a block of mortgage money from a commercial source and has agreed to subsidize consumers' payments for the first several years (or permanently, in some cases).
The builder, in other words, has put up money that will be chipped into the mortgage pot month by month. If the true cost of the builder's money is 14 percent, and buyers are paying 10 percent for the first year, the builder is responsible for the missing 4 percentage points for those 12 months. If the second year's effective rate to the purchaser is 12 percent, the builder has to fork over the missing 2 points.
Not being charities, most builders include the cost of such financing incentives in the retail price of their new houses. They commonly tack 6 to 8 points or more -- $6,000 to $8,000 on a house with a $100,000 mortgage -- to cover lender fees and the buy-downs. What the HOWE concept offers builders and their customers is the opportunity to shave the buy-down expenses off the front end of the transaction -- the price of the dwelling -- and to pay for them gradually over the first six to eight years of the mortgage.
The long-term contract rate on the fixed-rate HOWE loan is pegged at least 1 percentage point above the prevailing rate at the time of closing. The buyer doesn't actually pay that rate for several years. But over the typical life of a home mortgage -- roughly eight to 10 years -- the extra point should fully cover the initial buydown expenses.
If the home buyer pays off the loan earlier than the first six to eight years, a pro-rated portion of the actual buy-down cost is assessed against the principal debt owed the lender.
How does HOWE -- or its likely raft of fixed-rate imitators heading for the marketplace -- stack up for you as a potential buyer? The pluses are fairly obvious. The potential minuses are more subtle, but noteworthy.
On the plus side, you can qualify for your house at the lower initial-year rate (say, 10 percent) rather than at going market levels. You receive a true fixed-rate 30-year mortgage with a three-year buy-down, so you have guaranteed-payment predictability for as long as you own the house.
HOWE has an important potential minus, however: Although it is designed to enable builders to cut prices or increase the amenities on their units, nothing in the loan program itself ensures that a builder will do either.
One building firm, for instance, might cut prices on a $100,000 model to $95,000 under HOWE, or add $5,000 worth of luxury-grade appliances in the kitchen for the same price. A builder in another community, though, simply might advertise HOWE's 10 percent first-year rates, add no amenities and keep prices right where they were.
In such a case, the consumer would get a fixed-rate, long-term loan priced 1 point above the market, and get little or nothing tangible in return.
The upshot for the consumer: If you're going the fixed-rate HOWE route, make certain the builder shows you how the plan has cut his price or raised his amenities.