You've heard of the yuppie mortgage. You've read about SAMs, SEMs, wraps, rollovers, buydowns, balloons and all manner of ARMs. But you may not be familiar with this spring's latest creative wrinkle in the search for the ultimate real-estate loan: the elastic home mortgage.
It's brand new, and it may not be available yet at your local savings and loan association. But it's almost certainly on the way. The elastic home mortgage comes with:
*A monthly payment rate about two percentage points below the going charge for fixed-rate, long-term loans -- or about 11 percent currently.
* An ironclad guarantee from the lender that your initial monthly dollar payment for principal and interest never will change throughout the life of the mortgage. If you pay $900 a month at the start of your loan in 1985, you know with absolute certainty that that's what you'll be expected to pay in 1990 and 1995.
* Full legal right of assumability for qualified future purchasers of your home. You can pass on your loan at any time, in other words, to a buyer who can fill your financial shoes.
* The possibility of benefiting directly from future decreases in interest rates in the economy overall, even though your payment level is fixed in concrete.
* No penalties for early payoff of the loan, and no "negative amortization" -- the scary buildup of principal debt so common with certain below-market-rate loans.
Sound like an intriguing mix of consumer features? It is indeed. But the concept of the elastic mortgage -- now being test-marketed in the Midwest by a major lender, Minneapolis-based Lumbermen's Investment Corp., is more complex than it seems at first hearing.
The elastic home loan is one of 1985's growing ranks of housing-financing crossbreeds. It offers the predictable, unchanging monthly payments typical of a conventional, fixed-rate mortgage. But inside its fixed-payment body beats the heart of an adjustable-rate mortgage.
Every six months, the loan's "true" internal rate is adjusted to keep pace with the Treasury Department's long-term bond index. If rates in the economy have risen during the past half year, the internal, or true, annual percentage rate jumps in tandem. If rates have headed downward, so does the elastic mortgage's internal rate.
But how can monthly payments stay the same in an adjustable-rate mortgage without the possibility of negative amortization? And how can the consumer reap the benefits of lower rates if he or she is perpetually locked into payments that never change?
Here's where the elastic comes in. The new mortgage begins life as a 15-year home loan, with a total of 180 payments due over its estimated normal lifetime (12 times 15 equals 180). If and when interest rates decrease in future years, the elastic-mortgage's term -- that is, the total number of monthly payments required to pay off the principal -- begins to shrink. Instead of 168 additional payments due after the first year (180 minus 12), the total number of payments due might dip to 162 if rates drop over the year by half a percentage point.
If, on the other hand, rates move up during the year, the total number of payments might grow by five or six. The elastic loan manipulates the term of the mortgage to adjust for rate changes rather than varying the monthly amount of payments from borrowers. By so doing, it offers predictability to consumers worried about potential "rate shock" and provides the feel -- if not the substance -- of a fixed-rate mortgage.
Like other new adjustables, the elastic loan comes with some built-in consumer protections against huge rate run-ups in future years. It carries a four-percentage-point life-of-the-loan "cap," for example, a full point better than most adjustables.
By virtue of starting off as a 15-year mortgage, it also provides borrowers the opportunity of faster equity buildups in their homes through earlier retirement of principal. A 15-year "level action" (elastic) mortgage of $80,000 at 11 percent will require $83,670 in total interest payments over its life, according to calculations by Lumbermen's Investment Corp. A 30-year, fixed-rate, 13 percent loan of $80,000, by comparison, will require $238,585 in total interest payments.
What's the downside of the new elastic home mortgage? For starters, it's an adjustable -- no matter how fixed it feels -- and thus is subject to the winds of future rate increases. Second, its true annual percentage rate -- as opposed to its monthly payment rate -- is higher than you'll find for other adjustables (currently 13 percent). And its fixed monthly payments aren't for every consumer's budget, by any means. Fifteen-year terms always require higher monthly principal and interest payments in comparison with 30-year loans, a fact that no amount of elastic will overcome.