How would you like an adjustable mortgage that adjusts only down to lower percentage rates?

When the rate dropped you wouldn't have to file a refinance application, you wouldn't have an early pay off penalty and you wouldn't be saddled with new loan fees.

Think about it: an automatic refinance, without the hassle and without the cost of a traditional redone mortgage.

"Consumers have inherently disliked ARMs because the potential for higher rates and bigger monthly payments," said Peter G. Miller, creator of the consumer Web site, OurBroker.com. "But if we have a product where the initial rate is the cap rate, and if rates can only decline, then consumers will plainly want to consider this loan option. If the initial rate and associated costs for points and fees are within reason, this could be a very desirable mortgage product," said Miller, also author of the yet-to-be-released, "Common Sense Mortgage" (NTC/Contemporary). Well, it's here, though not without caveats generally associated with "innovation".

A small number of small lenders have begun to introduce just such a mortgage that could change the way mortgage lenders do business.

Always an innovator, California is serving up one. San Diego-based City Line Mortgage Corp. offers what it calls an "automatic rate reduction loan" for customers in Southern California, Arizona and Washington.

When the market rates drop by half a percentage point below your current rate, the mortgage lender refinances you to market level -- at zero cost.

To qualify for the reduction, mortgage holders must have a year-long on-time payment record and maintain their good credit standing and income at the level they were when they originally obtained the loan.

The other coast offers one too.

Fairfax, Va.-based Service Saver Finance will refinance with no closing fees when your loan rate is one-half to three-quarters of a percentage point higher than the going market rate. No credit checks, no appraisals, no income verifications. As with the City Line deal, you must have an excellent payment record.

What's the catch?

It's a gamble. First, to offset the risk of plummeting rates, lenders will likely charge more up front than a conventional mortgage.

"If you pay 1/4 percent more in the beginning, are you going to get the best rate with this mortgage?" asks Warren H. Myer, president of Myers Internet Services, a top-rated Web development company specializing in Web development services for mortgage companies.

"If rates are 7 percent and this mortgage is 7.25 percent and rates drop to like 6.75 percent, 6.75 percent might not be the best rate in the market," Myer said.

You might be better off paying the extra fees and suffering the traditional refinance hassle if you are going to stay in the home long enough to realize a better saving on the traditional refinance.

"It will be good for certain types of people with lower mortgages that are hard to refinance because you can't get the special deals that you can with the larger loans," Myer added.

The automatic refinance lenders have designed the loans to generate customer loyalty. Lenders often loose borrowers in droves whenever rates fall and home owners refinance elsewhere to get the best rate.

There are sizable profits to be had servicing loans -- collecting monthly escrow, principal, interest and property taxes as well as mortgage record-keeping. Servicers who buy servicing rights, collect annual fees for the work, as much as 0.5 percent of the loan amount -- for as long as the servicer can hold onto the loan.

If servicer holds onto loans it can afford to absorb lost closing costs from a traditional refinance because it won't lose servicing income.

"For people who are too busy to track rates or figure out the cost to refinance loans, this is for them. When you are taking out these loans just be sure to look at the alternatives," said personal finance advisor Eric Tyson, co-author of "Mortgages for Dummies" (IDG Books, $16.99).

Tyson also questions the new loans appeal in the current market. "This would have been good loan 10 years ago. Now, how much lower are rates going?" Tyson asked.

Published: May 7, 1999

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