Alternative Mortgage Instruments--Their Importance to You

This article appeared in the GAO Review, Vol. 15, Issue 3, Summer 1980. An audit effort is planned on the usefulness of alternative mortgage intruments and how these instruments have worked in the marketplace. The Federal Government pioneered in the standard mortgage, which is a fully amortized low downpayment, fixed rate, level payment mortgage instrument. This instrument was designed to operate in a relatively stable economic and financial environment. Since the mid-1960's, the American economy has had periods of high and/or rising interest rates, rapid inflation, and restrictive credit policies. The lack of flexibility in the standard mortgage causes borrowers to experience high monthly mortgage payments relative to their income. The standard mortgage does not take into account the buyer's long-term income expectation or housing needs. The lender experiences problems with the standard mortgage such as earnings do not keep pace with sharp increases in lender's cost of funds, cost of funds decrease the amount of funds available to support the mortgage market, and lenders are unable to pay their depositor the market rate of interest on their deposits. An alternative mortgage plan, the graduated payment mortgage, enables individuals to pay for their homes more easily in the earlier years. The mortgagor borrows additional money during the early years of the mortgage to reduce the monthly mortgage payments during this period. Slightly larger downpayments are required. The variable rate mortgage is now offered which allows the interest rate to change no more than once a year for a maximum of one-half of 1 percent. During the life of the mortgage, the interest rate can increase no more than 2.5 percent. It allows a downward adjustment in the mortgage interest rate without the problem of refinancing, and provides the lender with some interest risk protection. The rollover mortgage is a special case of the variable rate mortgage. Financial institutions can issue bonds, the yield of which determines the interest rate that institutions charge the borrower. The rate may change at the end of each 5-year bond term. Regulations limit the increase in the interest rate for the life of the mortgage to 5 percent. In periods of increasing interest rates, it allows the savings and loan industry to remain competitive with the rest of the money market and allows them to provide funds to new home purchasers.