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PERSONAL FINANCE / KATHY M. KRISTOF

YOUR MONEY : New Mortgages Might Not Be Best Way to Save

July 27, 1994|KATHY M. KRISTOF

A new breed of mortgages burst on the national scene Tuesday after the Federal National Mortgage Assn. gave its all-important blessing to the so-called Asset Integrated Mortgage--AIM for short--which promises to help you save while you pay off your mortgage.

AIM, which will initially be offered in 50 U.S. metropolitan areas, including Los Angeles and Orange counties, is one of several new hybrid mortgages that combine home loans with investments. A similar product, called the Money Back Home Loan, was recently launched in California. More than a dozen lenders are test-marketing similar hybrids.

Fannie Mae's approval of the AIM loan is likely to touch off a major push for these mortgages as banks struggle to boost loan demand in today's rising-interest-rate environment. Fannie Mae is important because it buys the loans from bankers, giving the banks cash to make more loans.

But consumers need to be wary. The loans are highly complex because they entwine your mortgage with an insurance product. You have to examine the terms of both the mortgage and the insurance "investment" to determine whether they're a good deal. Often they're not.

"The one thing these products have going for them is that they provide forced savings once you commit to them," says David Hemstreet, a Pasadena-based financial planner. That's valuable if you would not otherwise have the discipline to save. But if you're savvy and disciplined, you can probably do better on your own, he says.

A look at two of the recently introduced products--the AIM loan created by Financial Integration in Cleveland and the Money Back Home Loan, introduced by Investment Mortgage Corp. in Atlanta--illustrates why.

The AIM product works this way: You put 5% down on the house and put the other 15% that you would normally need for a 20% down payment into an insurance annuity, which is pledged as security for your loan.

Assuming you don't default and that you keep the loan and insurance annuity for the full 30-year term, you will have paid off your house and will have an annuity worth at least your original mortgage amount at the end of the period, AIM promoters say.

However, because you've used a substantial portion of your down payment on an insurance annuity, you've got a larger home loan--and bigger monthly payments.

Assuming you're buying a $100,000 home, you would pay $730.47 a month on a $95,000 loan at an 8.5% fixed interest rate, says Dennis Godfrey, director of new product development at Fannie Mae. If you went with a traditional loan program--with a 20% down payment--you'd pay $615.13 monthly, or about $115 a month less, Godfrey says.

Still sounds attractive? Consider what would happen instead if you put the 20% down on the house and invested the $115 a month difference--the $730 monthly cost of AIM minus the $615 monthly you'd pay on a traditional mortgage--in your 401(k) plan, which gives tax benefits similar to those of the annuity. Assuming you earn 6% on your investments, you would have accumulated more than $115,000 at the end of 30 years--$20,000 more than AIM promises.

There's another catch. AIM doesn't guarantee that you'll have $95,000 saved in 30 years. It estimates you'll have that much, based on the assumption that you'll earn at least 6% annually on your $15,000 investment in the insurance annuity. The "guaranteed rate"--the amount you'll earn regardless of market conditions--is just 4%. If you earn only 4% on your $15,000, your nest egg will be worth less than $50,000.

Additionally, if you want to get rid of the insurance policy early, you may have to refinance the home. The policy and the loan are separate, says Godfrey, but because the policy secures the loan, you'd have to kick in cash, refinance or prove you built up more than 20% equity in the home to let the policy lapse.

The Money Back Home Loan presents an even more troubling worst-case scenario.

With this loan, you make the traditional 20% down payment. But your monthly payments don't pay down principal: They pay interest on your loan balance and they buy an insurance policy.

Assuming you buy a $100,000 home and make the obligatory 20% down payment, you'd pay $566.67 on an interest-only 8.5% loan, says Godfrey. Then you add the cost of the insurance policy, which in this case would be roughly $83 a month. In total, the Money Back loan would cost $650 a month, compared to $615 for a traditional loan.

If the $83 you pay each month to the insurer earns an average of 8% annually, you'll have $123,700 accumulated in the policy at the end of the term. You "borrow" out $80,000 to pay off your loan--you avoid tax penalties by borrowing against the policy rather than cashing it in--and have $43,700 left. And all for just $35 extra a month.

What happens if your insurance policy pays just the guaranteed rate of 4%? You have only $57,606 accumulated in 30 years. And you still owe $80,000 on your mortgage. An ugly prospect.

And then there's the issue of alternatives. What happens if you get the traditional mortgage and invest the $35 difference in your 401(k) plan at an average annual return of 8%? In addition to a paid-off mortgage, you have $52,162 at the end of 30 years--or $8,462 more than you'd have with the comparable Money Back loan option.

"This is really a buyer-beware sort of deal," says Margie Mullen, a Los Angeles-based fee-only financial planner. If you don't need to be threatened with losing your house to inspire you to save, she says there are better options.

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