New hope for the American dream

By , Edwin B. Brooks Jr. is president of the U.S. League of Savings Associations.

Everyone has his favorite story about the "lucky neighbors" who bought their house only a few years ago using a mortgage with interest fixed for 30 years at some low, pre-inflation rate of six, seven, or eight percent. Now, however, more stories are being told of those less fortunate individuals who bought their houses with mortgages carrying fixed, 30-year interest rates as high as 16, 17, and even 18 percent.

The interest rate imbalance became so large at one point that it threatened a further and possibly even worse danger: a general cutoff of mortgage funds. As it turned out, mortgage money did become severely restricted toward the end of 1979 and the beginning of 1980.

But, while the rapidly mounting inflation of recent months may have interrupted the American dream of homeownership, new federal regulations allowing renegotiable rate mortgages provide hope that mortgages of the future will be able to keep pace with demand and economic conditions, to the benefit of the home buyer as well as the lender.

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The renegotiable rate mortgage (RRM) promises to be more responsive to modern consumer needs, permitting the periodic adjustment of its interest rate according to market pressures. In other words, if you were forced to seek a mortgage during a period of rising rates such as we had for over 18 months -- you wouldn't be stuck with the larger interest payments when rates declined. Your mortgage would be adjusted.

Similarly, the renegotiable rate mortgage would eliminate the inequity of making new homebuyers subsidize families with older, low-rate mortgages. The RRM would eventually make unnecessary the interest-rate premium that lenders are forced to charge new borrowers to compensate for below-market rate loans in their portfolio.

The only feature renegotiable in such a mortgage is its interest rate. The homebuyer is assured of a long-term mortgage commitment for up to 30 years through a series of short-term loans for three, four, or five years. Only as each of these short-term loans matures, could the interest rate be changed -- and then by only half a percent a year or a maximum of 1.5 percent over three years to 2.5 percent over five years. The actual amount of the interest rate change on a particular loan would depend on the length of the initial loan and the average national interest rate change over that period, according to an index published by the Federal Home Loan Bank Board.

However, cumulative interest-rate changes are limited to a maximum of five percent over the life of the original long-term mortgage commitment. And, while decreases are mandated during the periods of declining interest rates, increases are left to the discretion of the lending institution.

Except for this limited prospect of rate changes, the new type of mortgage offers the same long-term protection as the traditional fixed-rate mortgage. The RRM mortgage must be renewed at the end of each short-term loan period, even if the borrower has a poor repayment record.

The RRM is not going to displace entirely the standard fixed-rate mortgage instrument -- at least not any time soon. But it will provide a beneficial and competitive alternative and, ultimately, help streamline the mortgage lending process.

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