A guide through the thicket of home-mortgage options
Today's residential mortgage market and alphabet soup have a lot in common. Among the letter combinations floating around these days are GEMs, ARMs, and GPMs, plus more. So if you're looking for a house and require a mortgage, maybe you'd better sharpen up your mortgage-recognition quotient.
The sky-high interest rates of the last few years forced lenders to the drawing board to drum up new plans that could help home buyers, particularly first-time buyers. The typical monthly house payment jumped from $352.72 in 1978 to $624.70 in 1982, thus making new forms of mortgage instruments even more important.
The Federal National Mortgage Association (Fannie Mae) traded more than 150 kinds of mortgages last year. This is confusing enough to lenders, let alone the buyers barraged with numerous options.
Lenders now are in the process of trimming the pool to 7 or 8, or maybe 10, plans that are reliable and will be around long enough so that they will become familiar to consumers.
The familiar fixed-rate, 30-year mortgage weathered the interest-rate battering and is still the most popular option among buyers. But there are other , more flexible plans that can assist some buyers and are worth knowing about.
Much of the emphasis on alternative financing has come from the need to help first-time buyers - that is, without any equity in a house - make a purchase. The option for many such buyers has been the graduated-payment mortgage, or GPM.
High interest rates have also meant that a growing-equity mortgage, or GEM, has become increasingly attractive to many, as it means owning their home in just 15 years.
Growing-equity mortgage: The GEM, also known as an early-ownership mortgage, or EOM, is among the best options for a first purchase, according to Mark Korell , president of MGIC Mortgage Marketing Corporation. Unlike adjustable-rate mortgages (ARMs) and balloons, which have more risk in the equation, the GEM spells out exactly what a buyer's payments will be over the term of the loan.
GEM payments will increase 3 to 4 percent each year, Mr. Korell says, but he adds that since one-quarter to one-third of one's income typically goes to supporting a house, there is room to absorb gradually increased costs. And, he points out, ''you save a ton of interest.''
The initial payments are the same as on a 30-year, fixed-rate mortgage because the rate is lower due to shorter amortization, or payoff.
Graduated-payment mortgage: Here the buyer starts with low payments and builds up gradually. The idea is to qualify at a lower rate the first-time buyer whose income may be on the low side.
The catch is negative amortization, which means that the initial payments do not reduce the principal of the loan. Thus, if you have to sell, says Mr. Korell , it is possible that the outstanding balance may exceed the value of the house.
The MGIC executive says he feels there is a fair amount of risk with this mortgage, although it is quite popular.
A safer version of the GPM is the pledged-account GPM, which requires a builder or seller to put a given amount of money into a separate account. The buyer still pays a lower monthly amount, but this account is drawn on to make it a full payment.
A buy-down plan such as this is helpful to first-time buyers because it lessens their out-of-pocket payments. The only problem is that a builder who may be offering such a buy-down may also jack up the price of his house somewhat.
Adjustable-rate mortgage: The ARM is helpful particularly when interest rates are high.
While the most common types of ARMs are those that adjust the rate charged on the mortgage every six months or every year, MGIC's Korell expects to see a general move toward an instrument that adjusts the rate every three, five, or seven years. This is easier on the buyer, of course, and still frees the lender from getting locked into lower rates in the event they begin to rise.
In return for all this, the buyer gets a lower rate than he would be able to get on a fixed-rate, 30-year mortgage. A Fannie Mae fixed-rate mortgage, for example, was 13.25 percent on Feb. 23, while its five-year ARM was 12.18 percent.
Balloon: This is perhaps the most dangerous of alternative mortgages. Aptly named, the plan requires payments only on interest for a 3- to 5-year term, at which time the entire amount comes due.
It was homeowner inability to meet the unamortized full loan amount in the 1930s that launched the move toward long-term, fixed-rate mortgages.
The balloon mortgage can be useful to those who are absolutely sure they will move shortly after buying. Most lenders, however, warn buyers against becoming involved with a balloon mortgage.
A five-year adjustable-rate mortgage (ARM) is far safer, they say, because the source of financing is assured.