2 chances to obtain a cheaper mortgage Both work better on bigger loans, but each comes at a price

Nation's Housing

August 30, 1998|By Kenneth R. Harney

TWO CUT-RATE mortgage ideas that haven't been seen nationally for nearly two decades have resurfaced this summer and appear to be picking up significant steam.

Both plans allow homebuyers to qualify for interest rates below prevailing market levels. Both work especially well for "jumbo" loan borrowers -- those seeking mortgages above $227,000 -- and for buyers who know they're likely to sell or move sometime in the coming four to five years.

But both require you to strike a bargain of sorts with your lender.

You've got to give up something to get the discount rate.

The first oldie-but-goodie making a comeback is the prepayment-penalty plan. In exchange for a fixed 30-year interest rate that's about a quarter-percent below the regular rate, you agree not to refinance during the next 60 months.

After that, you're free to do whatever you want. During those first 60 months, you're free to pay off the loan without penalty if you move or sell the house for any reason.

But if you prepay the mortgage balance simply to refinance with another lender, you get hit with a penalty, the size of which varies according to state law.

In California, for example, the prepayment penalty can't exceed 80 percent of six months' interest.

In other states, where such prepayment penalties are subject to different statutory restrictions, the penalty may be different, or not permitted at all.

What do you get for a quarter-point rate break?

On a $300,000, 30-year mortgage at 6 3/4 percent, you save $50 a month -- $600 a year -- in principal and interest.

If $600 a year is chump change to you, then don't even think about the prepayment concept.

But if you figure that 30-year fixed mortgage rates are near their three-decade lows, and the odds are good that you won't be a serious refinance candidate in the next several years, then why not save some money?

On the other hand, if you think there's a chance that mortgage rates will dip below 6 percent soon, then risking a prepayment penalty makes no sense.

But growing numbers of homebuyers apparently think the rate break is worth it.

$100 million a month

One of the national lenders active in the prepayment-penalty arena -- Headlands Mortgage Co. of Larkspur, Calif. -- says it's originating more than $100 million a month in jumbo prepayment loans alone.

"We don't try to psychoanalyze our borrowers," says Peter Paul, president and CEO of Headlands.

"If they take [the rate break] and they know they're going to move sometime during the next five years and prepay the loan, that's fine," Paul says.

"We don't ask that question because you're allowed to sell without penalty anytime."

Headlands is also involved in the nationwide rollout of a second oldie-but-goodie this summer, the graduated payment mortgage (GPM) -- unseen in most places since the early 1980s.

Here's how it works.

Think of a GPM as a hybrid fixed-adjustable loan with a gradually ascending payment schedule in the early years.

You start with a very low rate for the first year, currently 4.89 percent.

That rate is designed to pull in homebuyers who couldn't afford ** the size loan they need at today's regular rates.

After one year of payments at the 4.89 percent start rate, the monthly payment -- not the interest rate -- in year two increases by 7.5 percent.

The same payment increase occurs in each of the next four years, and then the loan turns into a standard fixed-rate mortgage.

Not locked in

But you're not really locked in to those graduated increases for any specific number of years.

You can bail out -- refinance or sell -- without penalty anytime.

To illustrate one deft use of the loan, say you take out a $250,000 GPM at a 4.89 percent start rate.

Monthly principal and interest come to $1,286.02.

That's $376.48 a month less than the same 30-year loan at a fixed 7 percent -- $1,662.50.

At the beginning of the second year, your payment increases by a pre-set amount -- a little less than $100 a month -- to $1,382.45.

You're still $280 a month cheaper than the 7 percent alternative. By the third year, you're paying $1,486.

But in the fourth year, you get close to the 7 percent fixed

payment -- $1,597.60 -- and in year five, you cross the line, with a $1,717 monthly payment.

Time to refinance?

At this point, you probably should begin looking around for refinancing, unless, of course, interest rates have risen and your GPM payments are lower than what you'd get by refinancing.

One caveat on GPMs: Your early-year payment savings are financed, in effect, by turning unpaid interest into principal -- a process called "negative amortization."

When you refinance or sell, you'll find your loan balance grew by 2 percent to 3 percent.

But in today's strong housing appreciation environment, coming with that extra principal shouldn't be a major problem.

Kenneth R. Harney is a syndicated columnist. Send letters care of the Washington Post Writers Group, 1150 15th St. N.W., Washington, D.C. 20071.

Pub Date: 8/30/98

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