Three recent letters, beginning with Hermann P. Schlander, "Variable Rates Seem to Go Only One Way," have unfairly tarred today's adjustable rate mortgage (ARM) in apparent references to the old variable rate mortgage (VRM). These two home loans are distinctly different.
Interest rates have dropped on ARMs. One lender alone, Great Western Savings, offers for proof that more than 50,000 ARM holders cumulatively saved over $6 million last year as their payments declined and their interest rates fell.
It has been our members' experience that the conditions described in the letters refer to VRMs, which were issued from 1975 through about 1981.
VRMs were structured to allow the interest rate to change only once every six months. Each change in interest rate is limited to one-quarter of 1% and the interest rate cannot increase more than 2.5 percentage points over the initial rate. There is no limitation on the total amount by which interest rates may decrease.
The high interest-rate environment of the last years saw the prime rate reach double digits, yet VRMS could not, as designed by California law, rise proportionately. Most VRMs eventually reached their 2.5% life cap--which was below the interest rate of fixed-rate mortgages offered at the time.
But because interest rates on VRMs could not go up in the same magnitude as interest rates in general, they cannot decline at the same rate either. The index to which a VRM is tied must drop to a value that is less than 2.5% greater than the initial index before the loan interest rate can be reduced, and then a reduction can be made up to %--at each six-month interval.
There was no standardization for the margin, so virtually every VRM is affected differently. For a number of VRM borrowers, their interest rates are dropping; for others, their interest rate has remained stable, but could drop if the index continues to fall.
We hope this information helps prevent further confusion, or mislabeling of both yesterday's VRM and today's ARM.
Hallahan is senior vice president for public affairs of the California League of Savings Institutions.