Lenders are offering a variety of new loan products to stimulate business, including the 5-4-3-2-1 buydown and the step loan, as reported in American Banker on April 4.
One intriguing product that has been neglected is the fixed-rate loan that offers a teaser rate. At least two lenders offered this product back in the 1980s - General Electric under the brand name Equal, and Citicorp Mortgage with its Homeowner's Key.
The two offerings were essentially the same and enjoyed some success among customers because they offered effectively low rates during the first year or two.
Essentially, the product is a rapid-equity mortgage. The twist is that the lender reduces the initial payment by collecting interest only during the first year or two. By using what would have been the principal portion of the payment to buy down the rate, the lender is in effect able to offer a free payment equivalent to a teaser rate.
As with any rapid-equity mortgage, the payments will increase later according to a predetermined schedule so that the mortgage amortizes fully over 30 years.
Suppose a customer wishes to borrow $100,000 on a 30- year fixed-rate loan and the current rate is 8%. Then the customer's monthly payment, ignoring escrow, would be $733.76.
Most customers will qualify, close, and begin making this payment. However, the lender may have customers who will not qualify at this rate or who do not want to make a payment that large in the first year or two. Some would-be borrowers should be rejected for valid credit and income reasons, but if the lender is looking for a way to make the loan, he or she can offer the following terms:
Interest only for the first two years for a payment of $666.67.
A rate permanently fixed at 8%.
An increase in the payments in the third year to the full $733.76.
Additional increases in the payments each year until the payment is high enough to fully amortize the loan in 30 years.
If this were all there was to the loan, it would not be so remarkable. However, a clever marketer will realize that the initial payment, $666.67, is very close to the fully amortizing payment for a 30-year fixed-rate loan with a rate of 7% - actually $665.30. Thus, for a difference of $1.37 a month, the lender can advertise a free buydown to a 7% rate for a year (or two years if the customer's creditworthiness indicates).
This product should not be used by every lender for every customer. However, when put in a portfolio of other products, it allows the lender to gain a competitive edge over lenders who do not market such a loan.
The terms of the loan must be carefully explained to the customer, who should have a good understanding of the rapid-equity nature of the loan.
However, for those who represent good risks and understand the terms and cash flows, the loan is an excellent tool for bringing additional customers into the lender's offices and for building incremental volume.
Mr. Neagle is a manager with A.T. Kearney, a Chicago consulting firm owned by Electronic Data Systems in Plano, Tex.