No-down-payment mortgage alluring but it comes with more risk and fees

April 12, 1992|By Jim Johnson | Jim Johnson,McClatchy News Service

SACRAMENTO -- The Sacramento office of Merrill Lynch & Co. has been inundated with inquiries about its new no-down-payment, adjustable-rate mortgage that's being test-marketed in California.

"Most of the calls have come from real estate agents and homebuilders," said Brian W. Fox, an executive at the local office. "They are ecstatic."

The response from some mortgage market analysts has been less effusive. The "Parent Power" program, which could be expanded to other states, is alluring and innovative, but it poses more risk and higher fees than usual, they contend.

And there is a trade-off for the no-down-payment feature: The borrower must get someone to pledge more than 30 percent of the house's purchase price as collateral by placing it into an account with the brokerage company.

The "Parent Power" program began with a 25-year, adjustable-rate mortgage tied to the prime rate. The minimum loan available under the program is $100,000. Borrowers pay the prime rate, plus half a percentage point, on amounts up to $199,000; the prime rate plus a quarter percent between $200,000 and $299,000; and the prime between $299,000 and $599,000.

The rate is adjusted twice a year and has a lifetime cap of 18 percent. Some other adjustables can change rates twice a year, but their average lifetime cap is 5 percent.

Merrill said the program has three objectives: To provide financing for cash-poor borrowers who would not otherwise be able to buy a house; to enable parents and others who traditionally have helped to provide that cash to keep their investments and earnings on them intact; and to bring assets into Merrill Lynch from other brokerages.

Still, some mortgage specialists say most homebuyers will discover the magic is a combination of blue smoke, mirrors and marketing sleight of hand.

"I can imagine that people would get excited about a no-down-payment loan, and the phone would ring off the hook -- unless they understood the list of things you need to get in the door," said Earl Peattie, president of Mortgage News Co. of Santa Ana, Calif. "But give Merrill Lynch a 'C' for trying."

"It sounds like fun with numbers. . . ." said Larry Ward, vice president of operations for the Mortgage Market in Dublin, Calif. "And how many people in the real world are in the position where Mom and Dad are stock heavy and can pledge that much?"

The sponsors' commitment is greater than the amount of a 30 percent down payment because Merrill Lynch wants protection against price fluctuations in securities or declines in home values. The lender demands that sponsors pledging securities must deposit 130 percent of the down payment, while those pledging equity must establish a home-equity account 10 percent higher than the guaranteed amount.

On a $150,000 loan, for example, a borrower would need $45,000 worth of securities as collateral, plus

an additional 30 percent of that amount -- a total of $58,550. If home equity is pledged as collateral, only an additional 10 percent cushion -- or a total of $49,500 -- would be required to guarantee the $150,000 loan.

If the value of the pledged securities falls to less than 110 percent of the down payment, the sponsors must supplement the account and maintain a 110 percent balance. The sponsors' pledges are committed until the borrowers pay off 30 percent of the loan or until seven years have passed and an appraisal shows the borrowers' equity matches the down payment.

In addition, sponsors must pay upfront fees of $300 to $500 and an annual fee equal to 2 percent of the down payment. If Merrill Lynch meets its goal to approve 1,000 loans averaging $200,000 by year's end, it will manage $66 million to $78 million in pledges.

"I can see some very arcane situations where it would make sense, but there are a lot more situations where it doesn't," said John Karevoll of Dataquick Information Systems of La Jolla, Calif.

"For well-established parents who have discretionary income they can invest . . . it gets two birds with one stone."

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