If you're planning to finance a new home or refinance your mortgage this fall, look for a new wave of discount-rate adjustable loans aimed at people who can't stand bumps or shocks in their monthly payments, but who love to save on interest costs.
The fixed-payment adjustable-rate loan -- a computer-created financial hybrid -- is the latest landmark in lenders' search for the Perfect Mortgage, the loan no one can refuse. Perfect it's not. Irresistible it certainly is not. But intriguing it is, particularly in view of the volatility that's plaguing the capital markets. Here's what it's all about:
Take a look at the home mortgage field this weekend. Traditional fixed-rate, 30-year loans have been in double digits since spring, and they're inching up again with the turmoil in the bond market. Fifteen-year, fixed-rate loans are one-half to three-quarters of a percentage point lower on average. But they, too, are creeping into double digits.
Adjustable-rate mortgages (ARMs) have been in the single digits for months. They've jumped from 20 percent of loan volume in 1986 to well over half at many lending institutions this summer. With year-to-year rate-change caps, life-of-the-loan ceilings plus options to convert to fixed-rate loans, adjustables in the 7 1/2 to 8 1/2 percent range have been hard to beat.
The problem with adjustables, though, is that they often seem better the first year than they do in subsequent years. Even when the underlying index used by the lender rises only modestly, the jump in payments from the first to second year can be stunning -- $100, $200 or even more with larger mortgages. So can the jump from the second to third year, if the index continues to move up and the loan "margin" -- the spread tacked on to the index governing the rate -- is 2 1/2 percentage points or more.
Uncertainty is the fatal flaw of the adjustable mortgage for large numbers of borrowers. They like the 8 percent and lower starting rates. They like the possibility that their payments could decrease if rates plummeted. But they dread the reverse: that they hit the 6 percentage point life-of-the-loan rate-increase ceiling a few years down the road, and their attractive 8 percent mortgage turns into a 14 percent mortgage, with monthly payments to match.
Is it possible to take home-buyers' fears of uncertainty out of adjustables without losing the rate-saving sizzle? Is it possible to achieve this without forcing consumers into financial shoals such as "negative amortization" -- a buildup of principal debt whenever interest rates increase?
A handful of computer-savvy mortgage-market innovators across the nation have been working on that concept. Some of their efforts are on the verge of bearing fruit, potentially in a big way. Farthest along is the Boston-based Mortgage Refinance Corp. In the final week of August, it unveiled and began offering what it says is the nation's first fully adjustable-rate mortgage with a guaranteed fixed-payment, at an 8 percent rate.
Dubbed the "ARMlock," the trademarked mortgage plan is being licensed to other lenders in New England this month and should be available elsewhere in the next two months, according to the firm's president, William A. Roper Jr. The key to the ARMlock is a proprietary algorithm, a mathematical formula that allows monthly payments to remain the same, even as interest rates vary from year to year. The algorithm mixes principal, interest and payoff terms to produce a steady monthly payment, without negative amortization or lump-sum balloon payoffs at the end.
Like regular adjustables, the ARMlock comes with rate caps, a Treasury-based index, 2 1/2-point margin and annual adjustments. Your basic rate can't jump by more than two percentage points per year, nor by more than five points over the life of the loan. It's fully assumable, available in jumbo sizes up to $500,000 and is open to owner-occupied as well as investor-owned homes and condominiums.
What sets it apart is its fixed monthly payment for as long as 25 years. Take out an 8 percent rate-capped $100,000 ARMlock this month and your first payment will be $1,042.82. Ten years from now your monthly payment will be the same, no matter what happened to interest rates in the interim.
What may have changed, of course, is your underlying interest rate, and your mix of principal and interest. Your rate may have hit the five-percentage-point rate cap, and extended the term of your loan. Or the rate may have declined, thereby shortening your term. If rates averaged out to be the same as today's, your expected loan term with the ARMlock would be about 14 to 15 years.
The downside to fixed-rate adjustables, whether the ARMlock or other plans on the way? Look for higher monthly payments -- and principal reduction -- than via "straight" ARMs. That makes fixed-payment ARMs more attractive to refinancers and move-up buyers than to first-timers. ARMs control, in other words, may not be in everyone's interest.