Mapping The Right Path Through The Mortgage Maze

Thirty-year fixed mortgage rates finally broke the 9% barrier in October, putting more pressure on prospective home buyers. Although 9% was low in the 1980s, rates haven't been this high since March, 1992. But the number of loan options has never been higher. Especially with adjustable-rate mortgages (arms), which now make up nearly half of new-home loans, lenders are bending over backward to tailor products to borrowers' needs. Some arms, for example, are tied to an index that changes slowly, making them a better deal when rates are rising. Others let you lock in for long periods of time before adjusting, thus offering lower rates than 30-year mortgages while protecting against future rate increases.

SLOW MOVERS. When shopping for the best loan fit, it's important to consider how long you plan to stay in your home. If you're settling down for the long haul, 30-year mortgages aren't exorbitant and may still be your best bet. But if you think you're going to stick around for 10 years or less, look for an arm that will stay fixed that long. In general, mortgage brokers who work with numerous lenders provide an efficient means of finding generous loan terms. Also, savings and loans, savings banks, and credit unions offer the lowest rates, including the best below-market teaser rates for the first year of an arm.

One product that's gaining more attention as rates climb is the one-month arm linked to the Federal Home Loan Bank's 11th District Cost of Funds Index (cofi). Most mortgage rates are based on indexes linked to Treasury averages, but cofi loans are tied to an index that reflects how much banks in the Southwest pay their depositors, and "banks will keep those rates as low as possible," says Paul Havemann, vice-president of hsh Associates in Butler, N.J., which tracks mortgage information.

COFI rates fluctuate less and move more slowly than rates based on Treasuries--an attractive feature in a rising-rate environment. While the current one-year Treasury average is 6%, the cofi is only 3.9%. And while the one-year Treasury moved as much as 5.5 points when rates spiked in 1980, the cofi only varied by 1.3 points. "It will take a long time for the cofi to catch up. It may not ever rise if current rates begin to fall," says Peter Miller, author of The Common-Sense Mortgage and numerous real estate books.

HOPPING HYBRIDS. Although your rate could fluctuate every month, "the difference will be very small," says Margaret Scott, president of Mortgage Advisory Services, a New York broker. She thinks cofis are a better deal than one-year arms because when you look past the initial rate to the real cost of the loan, they offer "the best fully indexed rate." That is, when you add the lender's profit of 2.75% to the 6% one-year Treasury index, the real rate on the one-year arm is currently almost 9%--not much cheaper than a 30-year fixed. Meanwhile, the fully indexed cofi arm would be only 6.75%.

Though rare, some cofi loans can be found that stay fixed for six months and occasionally even a year, but the starting rate is much higher than loans that adjust monthly. For example, Klamath First Federal Savings in Klamath, Ore., has a one-year cofi at 81/8% with no points. Most cofis start at a tempting 2% to 4% for the first three months, then jump about three points to cover the lender's profit margin. Although cofis move up slowly, they're usually capped at 11% to 12%. Also, they lag the market when rates are falling.

Borrowers commonly have the option of making a fixed payment and deferring additional amounts caused by rate fluctuations. The biggest danger in choosing this setup is that you can fall into a negative amortization situation if you're not careful. When rates rise, the additional interest is added to the loan principal. So you wind up paying off more than your original loan amount. Thus Scott recommends paying the corresponding amount of interest and principal each month. Better yet, says Miller, get a cofi that doesn't allow negative amortization. While you're at it, ask for a loan that lets you convert to a fixed rate within five years. More common on the West Coast, cofis are starting to multiply in the Northeast and Southeast. If no banks in your area offer them, mortgage brokers usually do.

Also flourishing as rates inch up are hybrid loans that are fixed for a set number of years and then become adjustable. You can get them with the fixed portion lasting from 1 to 10 years. Of course the longer the fixed period, the higher the rate. The national average for loans that stay fixed for 10 years before becoming one-year adjustables is 8.32%, vs. 7.93% for loans that stay fixed for five years, vs. 7.57% for those remaining fixed for three years. Some lenders are even offering hybrid loans that adjust every six months after the fixed period. Chemical Bank's Residential Mortgage Corp. has a three-year hybrid that starts at 8% for three years and then switches to a six-month adjustable. That compares with an initial 85/8% for a loan that adjusts every three years.

Watch out: When they become adjustable, hybrids can jump as much as five points. So only pick these loans if you're likely to move or be able to pay them off before the fixed period ends, says Stephen Brobeck, executive director of the Consumer Federation of America. Also make sure that the hybrid you get is a 30-year commitment. Some lenders reserve the right to not renew the loan if rates exceed a certain amount.

NOTHING DOWN. David Reed of mortgage broker Morfacts in San Diego says he is seeing an increasing number of buy-down loans. These are 30-year fixed mortgages that allow you to pay less for a few years. For example, if you got a 9% fixed-rate mortgage, you would pay 7% for the first year, 8% for the second year, and 9% from the third year on. These loans aren't giving you a discount. You will pay the difference on the lower rates via points or with a slightly higher fixed rate. The advantage, says Reed, is that the lower initial rate makes it easier for people to qualify, and the points are tax-


Buyers who might not otherwise be able to afford a downpayment might seek out a zero-downpayment 30-year loan. North American Mortgage, based in Santa Rosa, Calif. (707 546-3310), allows parents to guarantee 10% of a child's mortgage in place of a downpayment, using the equity in their home or other assets as collateral. Merrill Lynch (800 854-7154) will waive the downpayment if the parents guarantee 30% of the mortgage with cash and securities in a brokerage account.

John Koch, chairman of the mortgage finance committee of the Savings & Community Bankers of America, says many thrifts are offering no-cost, no-points loans, where upfront closing costs and points are covered by adding 25 basis points to the rate. A typical closing cost at his bank, Charter One in Cleveland, would run $1,000 on an $80,000 loan. "If a borrower pays 0.25% more a year and intends to move in four years, he or she is ahead of the game," he says. But beware of prepayment penalties.

Some thrifts, such as Home Federal Savings in Lakewood, Ohio, are offering arms that have a 1% cap each time they adjust rather than 2%. The rate starts at 7.5% and can go up a maximum of 3% over the life of the loan, but the mortgage must be paid off in 12 years.

"ENORMOUS CONTROL." Sifting through these options can be mind-boggling, but remember, too, this is the biggest purchase many people ever make. Start with getting a sense of the rates available in your area. These are printed regularly in local newspapers. hsh can provide a listing of all the lenders in your region and their rates for $20 (800 873-2837).

Call more than one bank or broker and play off one against the other to get the best deal. "Borrowers have to realize they have enormous control over this process," says Peter Miller. "Lenders have to compete for your dollars." You would be wise to get a copy of your credit rating to anticipate any problems that might come up in qualifying for a loan. trw will give you one free copy a year (800 392-1122).

Bear in mind that the lowest rate doesn't always mean the cheapest loan. Each point you must pay may add about an eighth of a point to the effective rate on a 30-year mortgage. And if there's negative amortization, you can wind up shelling out much more than you intended in the long run. But even as rates drift up, you can ferret out favorable terms if you're fore-armed.

      1-MONTH ARM
         2.75% 1.5POINTS
      Dale Mortgage
      Bankers Corp., Conn.
         3.25% 1POINT
      Coast Federal Bank FSB, Calif.
         3.75% 1.5POINTS
      Savings Of America, Fla.
          4.13% 2POINTS
      New Jersey Savings, N.J.
         4.75% 2POINTS
      Mortgage Consultants, Calif.
         5.125% 0POINTS
      First Federal S&L, Mo.
         4.5% 2POINTS
      pnc Mortgage, N.C.
         7.125% 1POINT
      Columbia Savings, N.J.
         8.5% 1POINT
      Bank One, Denver
         7.75% 0POINTS
      Northern Financial, Mich.
         7.375% 2POINTS
      Great Southern Mortgage, N.C.
         8.375% 2POINTS
      West Essex Savings, N.J.
         8.375% 2POINTS
      First Savings of Renton, Wash.
         8.52% 2POINTS
      Thid Federal S&L, Ohio
      8.375% 2POINTS
      Great Southern Mortgage, N.C.
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