Finally, a mortgage with built-in savings

Nation's Housing

It never goes up, but can refinance itself downward

May 02, 1999|By Kenneth R. Harney

THE IDEA is so simple and attractive you wonder why millions of American homebuyers have never been offered it: A mortgage with a rate that can never go higher, but that refinances itself lower -- with no closing fees to the borrower -- whenever interest rates in the economy decline.

It sounds straightforward, yet it's a revolutionary concept in the mortgage industry. Since the advent of the modern, 30-year, amortizing home loan in the 1930s, the only widely adopted major pricing innovation in home financing has been the adjustable-rate mortgage (ARM) back in the 1970s. And ARMs, of course, carry interest rates that rise as well as fall.

Why not give homebuyers a financing tool that cuts them in, at no charge and no hassle, whenever the cost of money drops, but that protects them against payment jumps when interest rates increase?

The answer to that question is slowly emerging in scattered markets around the country, where consumer-savvy lenders -- primarily smaller mortgage companies -- have begun introducing what may be the mortgage of the 21st century. It goes by different names, but the concept is basically the same.

On the East Coast, clients of Fairfax, Va.-based Service Saver Finance can refinance with no closing fees when their mortgage r ate is as little as one-half a percentage point to three-quarters of a percentage point higher than the going market rate. There are no credit checks, no appraisals, no income verifications required. The sole requirement is that borrowers must have been on time with their mortgage payments during the prior 12 months.

In Southern California, Arizona and Washington state, clients of San Diego-based City Line Mortgage Corp. are lining up for what the firm calls the "automatic rate reduction loan." Anytime market rates drop by half a percentage point below the borrower's current rate, the mortgage bank will refinance the borrower to market level, with zero closing charges. To qualify for the reduction, clients must have a 12-month on-time payment record and must have maintained the "creditworthiness" and income levels that they had when they obtained their original loan.

The automatic rate-reduction concept could be heading to a lender near you as well.

Service Saver Finance has begun pitching its program to large mortgage companies nationwide. Service Saver's approach emphasizes "customer retention" for mortgage bankers who typically lose borrowers in droves whenever rates fall and homeowners refinance with competitors. City Line Mortgage is working with groups of small lenders to spread the idea "as a fundamental product improvement for the homebuyer," says President James C. Riley.

What's behind the rate-reduction idea, and why might it change traditional mortgage practices? Economics.

Borrowers might not be aware of it, but some of the heftiest profits from a mortgage are generated by the "servicing" of the loan. Servicing means the administration of the mortgage after it is closed -- the monthly collection of escrow, principal and interest, payment of property taxes, recordkeeping and the like.

Servicers -- who often buy the rights to service a loan from the originating lender -- collect annual fees for their work, frequently three-eighths to one-half percent of the loan amount. Multiply those fees by the billions of dollars' worth of loans in many servicing portfolios, and you get some impressive income.

But every time a borrower refinances and switches to a new lender, the servicer loses money. The smart servicer, says Keith Kelly, managing director of Service Saver, "understands that the name of the game is retain their customers for as long as possible." The key to retention, say advocates like Kelly and Riley, is to make borrowers an offer they can't rationally refuse: We'll lower your rate and charge you nothing for the reduction. You can start paying the lower rate next month.

How can lenders or servicers afford it? In City Line's case, the firm both originates and services the loans it makes. By absorbing the closing costs of a refinance -- title, credit, etc. -- the firm can avoid the servicing income losses of mass refinancings. As a high-volume user, Riley also gets rock-bottom discount prices on key closing services -- 50 percent off on title changes, for example. Riley says the new plan has been effective in retaining 95 percent of the borrowers who qualify, plus it's pulling in substantial new home-loan business.

Service Saver's Kelly says his firm's program retains 90 percent of the customers who qualify. That's despite the fact borrowers end up with rates slightly above the prevailing market -- 7.25 percent in today's 7 percent environment -- after the refinance, to help defray the costs of the transaction.

How soon until you're offered an automatic, no-closing-cost rate-reduction plan? Ask your own servicer. And watch for lenders to start rolling it out.

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: 5/02/99

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