Shop around for best mortgage deal

September 13, 1992|By James M. Woodard | James M. Woodard,Copley News Service

When shopping for the best home financing loan, the low interest rates offered for adjustable rate mortgages may appeal to you. But take special note of the index used to determine the future changes in the loan's interest rate.

One index could be 100 times more volatile than another, according to a report from Great Western Financial Corp. Translation: some indexes are much more likely to zoom up or down than others, significantly increasing your risk. Those rate adjustments will directly affect the amount you pay in monthly mortgage payments.

The Certificate of Deposit index is probably the most volatile of all currently used indexes. And this index is used with an increasing number of mortgage loan offerings.

"An ARM loan tied to a CD index is much more volatile than one using a Federal Cost of Funds Index," the Great Western report )) stated. "This can result in serious 'payment shock' for borrowers."

Generally, these loans do not offer annual payment caps, as do loans using other indexes. If interest rates increase an average of 2 percentage points a year over four years, borrowers could see their monthly mortgage payments increase 56 percent, the report pointed out.

VTC During the same period, if the borrower had a loan tied to a Cost of Funds index, the increase would have been about 24 percent.

On the other hand, when you take a high-risk CD-index mortgage loan, you can usually benefit from a lower initial interest rate than other ARMs offer. That index also could potentially go down as fast as it goes up. But with today's mortgage interest rates at a 20-year low, it's more likely the interest rate curve will go upward.

Consider the history of index rates. The 6-month CD index rose about 14 percent over 21 months between October 1980 and June 1982. The highest Cost of Funds index was 13.6 percent for one month (October 1981).

More recently, the CD index was 10.53 percent in March 1989. The Cost of Funds index at that time was 8.8 percent.

"If I were buying and financing a home at this time, I would prefer an adjustable rate mortgage tied to the one-year Treasury Bill index," said Tom Cross, a regional sales manager for First Nationwide Bank. "This index is comparatively stable and calculates interest rate changes only once per year.

"And it limits increases to a maximum of 2 percentage points per year. There's no possibility of 'negative amortization' with these loans."

Loans tied to a Cost of Funds index can change interest rates monthly, but the total payment stays the same for one-year increments. So if the interest rate increases to the point where the interest amount is greater than the payment, the overage is added to the loan balance, thus creating negative amortization.

"It's vitally important that borrowers learn and understand all aspects of the adjustable rate loan they are considering, including information about the index that will be used to determine future rates," Mr. Cross said. "A lot of people just don't understand these loans. It's always a good idea to %J consider a worse-case scenario."

Mr. Cross noted that most of his current loan applications are for fixed-rate mortgage loans.

"About 70 percent of our recent applications are for fixed-rate loans, and about 40 percent of those applications are for 15-year loans [as opposed to the more conventional 30-year loans].

"With today's low interest rates, most people want to lock in a firm rate on their new home financing or refinancing mortgage loan."

If you do select an ARM loan, be sure to periodically check your changing interest rate against the index used as the loan matures. Several recent surveys have revealed an alarming number of cases where lenders miscalculate their loan rate adjustments.

These surveys have been conducted by such credible groups as the Federal Deposit Insurance Corp., National Credit Union Administration and Office of Thrift Supervision. They have determined miscalculations in rate adjustments have been made 20 percent to 38 percent of ARM loans.

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