We're not talking about interest rates. New products and new ways to get information open up the possibilities for buyers.

by James T. Berger   Most people can’t buy a home with cash. So it’s in the broker’s or agent’s best interest to know what kind of mortgages are available.

Products range from the tried and true conventional 30-year and 15-year fixed mortgages to lesser-known exotic and hybrid adjustable rate mortgages. Moreover, there are products for the credit-challenged subprime borrower as well as jumbo and super-jumbo mortgages for the wealthy. Even people with little cash can buy a home by using their collateral in their stock portfolios as a down payment for a the mortgage.

ARMs making a comeback
Texas, like the rest of the country, is experiencing a return to the adjustable rate mortgage (ARM). However, the product of preference to the Texas borrower remains the 30- and 15-year conventional fixed mortgage. Arms that are on rise are the "hybrids," which combine both a fixed and adjustable rate. For example, a 30-year ARM mortgage would be a fixed rate mortgage for five, seven, or ten years before the rates could start adjusting upward or downward. If the spread between conventional mortgage and ARM exceeds 2%, look for a major rise in ARM volume.

There are a couple of more exotic Arms staging a comeback on the national mortgage market: the COFI ARM, which stands for Cost of Funds Index, and the Treasury ARM. Back in 1994, the Treasury ARM was responsible for 24% of the market, and the COFI ARM was responsible for 17% of the market. As interest rates for fixed-rate mortgages declined, the market for the ARM dried up. However, rising interest rates have revitalized adjustable rate mortgages.

Both the COFI and Treasury ARM are tied to money market indexes. The payback provisions can be rather complicated. Both products offer the option of making monthly payments several different ways. The borrower can make a below-market interest payment (paying less than what is owed), an interest-only payment (which is referred to as the "fully indexed rate"), or a fully amortized rate payment (which includes the usual interest plus principal).

The danger of the below-market interest payment is something called "negative amortization," which results when the payment isn’t enough to cover the interest that’s due. That difference is then added to the loan principal. These exotic Arms are good products for disciplined, rate-conscious borrowers. For the undisciplined, they can be a disaster.

Subprime opportunities
There is another highly significant trend in the mortgage business. A whole new strata of customers–subprime borrowers–heretofore overlooked by many financial institutions now have the opportunity to be homeowners.

Subprime lending has become one of the hottest areas in mortgage lending. Banks and mortgage brokers have focused on this market because the prime borrower (one with perfect credit) is hard to find, and the subprime lender commands a higher rate of interest because of the increased risk. While the possibility of default is higher with a subprime mortgage, the bottom line is that nobody wants to lose their home. After all, the lender has the house as security.

There are a variety of subprime lending programs. The Office of Thrift Supervision of the U.S. Treasury Department recently unveiled what it calls a Track Record Adjusted Mortgage (TRAM). TRAMs are directed at people with subprime credit who are committed to improving it. As the borrower’s credit improves, the interest rate declines.

Full Spectrum Lending, a national mortgage brokerage firm, has a similar product called the Credit Repair Mortgage. It provides borrowers with the stability of a fixed rate mortgage for the first two years and permits the borrower to repair his credit during this period. If the borrower proves creditworthy, Full Spectrum will write a conventional mortgage.

GMAC Mortgage Corp. has a subprime division that attempts to upgrade borrowers as they show more credit reliability.

Jumbos and super jumbos
The recent news of the Clintons’ purchase of a $1.7 million home with a $1.36 million mortgage provides insight into a special category of mortgage–the super jumbo.

Much is written about the "rules" for getting a conventional mortgage, which goes up to $252,700, and even the jumbo mortgage, which goes from $252,700 to $650,000. The super jumbo represents the stratosphere in home borrowing. In many cases, conventional rules don’t apply. Banks issue them to their nearest and dearest customers, and very few of them are bundled and sold to investors. You are unlikely to see any brochures on super jumbos in bank lobbies. This type of loan is often handled at the "private bank," a form of bank club for wealthy customers. Many banks who write super jumbos keep them in-house. This means that if a customer runs into financial trouble, the bank writing the super jumbo can take a major hit.

Many super jumbo customers are corporate executives at companies with major relationships with the financial institution. The big mortgage for the key executive is just another way to cement the relationship. In other cases, it may be a case of reciprocity. A company might shift accounts into a bank in exchange for the super jumbo mortgage for a key executive.

Stock portfolio as a down payment
The dramatic rise in the stock market combined with the movement of big brokerage houses into exotic financial-services products has created a new type of mortgage where a lien on a stock or bond portfolio is used for the down payment.

Here is essentially how the product works. Instead of putting up a cash down payment, the buyer puts up his or her stock portfolio as collateral for a down payment. The rest of the mortgage is financed through a traditional mortgage contract. The buyer continues to own the portfolio and obtain income from it in the form of dividends and capital gains. At the same time, that buyer is getting the tax advantage of essentially a 100% mortgage.

The process is also called "cross-collateralization." The bank or mortgage company is essentially taking two things as collateral–the house and the stock portfolio.

Take the example of a $1 million mortgage. Let’s say the buyer has $500,000 in income, but for tax reasons, she wants to leverage a mortgage of $1 million. What the bank will do is take the house as collateral and lend up to $750,000 on the house. The other $250,000 is not only secured by the house but also by a stock/bond portfolio of, say, $500,000.

The quality of the portfolio is quite important for this kind of a deal. Banks would be more inclined toward blue chips like AT&T and IBM instead of high-flying upstarts like Amazon or Yahoo. The reason why this is such a good deal for the customer is that the person doesn’t have to liquidate the stocks, and she has all the advantages of IRS deductions.

As brokerage firms have expanded beyond the bounds of simply buying and selling stocks on commission for clients, this type of financial services product creates value for these firms. Merrill Lynch and Morgan Stanley Dean Witter have had programs like this for several years. Last year, Fidelity Investments, the mutual funds giant, began marketing a similar program with GMAC Mortgage Corp. Salomon Smith Barney recently told Barron’s that it uses this approach for 40% of its home-loan applications.

The trend to online
Like the rest of the country, Texans are besieged by the online mortgage companies. Unlike the rest of the country, a Web-based mortgage company has to have a "brick and mortar" office and an officer somewhere in the state to do online business.

Hardly a day goes by before another mortgage Web site introduces yet another way to secure a mortgage over the computer. Advertising for these online services is everywhere. So far, customers aren’t buying, according to several knowledgeable sources. One key reason is concern for privacy issues. Many borrowers are reluctant to reveal important information online.

"The Internet is having no real impact yet," according to Chris Canedy, Chicago-based senior vice president of Chicago Title CastleLink, an online service that provides information to mortgage originators such as banks and mortgage brokers. "Less than one percent of originations are coming from online lenders."

The feelings were echoed by Tom LaMalfa, principal of Wholesale Access, which tracks the mortgage industry. "The Internet accounts for less than one and a half percent of the activity, and only in leads generated," he said. "It has become a giant bulletin board where borrowers can look at rates and determine what is being offered. I, personally, have big concerns about the privacy issue," he added.

"I don’t think the Internet will ever make a big impact in Texas," said Gary Akright, president of the Texas Association of Mortgage Brokers. "People will use the Internet to get rate information, but when it comes to doing a deal, they want to be represented by a real person. What are you going to do at the closing if you have a problem? Punch the help key on your laptop?"

Web-based business-to-business products
A final national trend that Texans will benefit from are new Web-based systems for REALTORS^®, mortgage brokers, title companies, and bankers that bundle elements of the mortgage process and that have the potential to greatly speed up the process of securing a home mortgage.

One new Web system is eMagic.com, a product of Milwaukee-based Mortgage Guarantee Insurance Corporation (MGIC), the nation’s leading provider of private mortgage insurance. This site seeks to enable mortgage originators (i.e. banks, mortgage brokers) to obtain appraisal reports, credit reports, title reports, flood determination reports, mortgage insurance reports, and other data all from a single source.

They recently announced a partnership with Chicago Title’s CastleLink subsidiary that brings the eMagic vision closer to reality.

"This product can accelerate the whole mortgage origination system," said Geoffrey Cooper, a spokesman for eMagic. "It is a point of entry for the originator. The borrower sits down with his mortgage broker or bank loan officer and together they log on to eMagic.com. We are embedded in the loan origination system, where the original application is taken. Together the borrower and loan officer piece together all the items and reports needed to develop the mortgage documentation."

Another new e-commerce product for banks and mortgage brokers promises to offer advantages to people seeking additional choices for first mortgages and home equity loans. IMX Exchange, a leader in e-commerce for the wholesale mortgage industry, announced that it has been issued a patent for its real-time trading system.

The IMX invention provides a method and system for trading loans in real time, enabling brokers to make loan applications and place them up for bid by a number of potential lenders. A transaction server (i.e. mortgage loan officer or broker) maintains a database of pending loan applications and their status.

Loan originators can review the status of pending loan applications and are notified of and can accept a lender’s bid when it is received. Lenders can search the database for particular types of loans, sort selected loans by specific criteria, bid on loan applications, and are notified when their bid is accepted.

"This system may result in lower interest rates for the borrower," said Heather Moran, corporate communications manager. "By having one’s bank or mortgage broker participate in this IMX Exchange system, the borrower is in a position to get the best possible rate and terms for his or her mortgage."

Moran emphasizes that this is strictly a product for loan originators. "The system is built for the broker. Any benefits to the consumer will trickle down to the borrower," she said. "By using a broker or loan officer plugged into this system, the borrower has a competitive edge because it opens up a whole new world of choice."

James T. Berger is a Northbrook, IL-based freelance writer and marketing consultant in the banking and mortgage field. E-mail him at j-berger@nwu.edu.

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