AIMs are an alternative to traditional mortgage financing - asset integrated mortgages

Healthcare Financial Management, Feb, 1995 by William G. Kistner

Buying a new house always has been related to the amount of debt a purchaser can afford to pay back. With the recent introduction of asset integrated mortgages (AIMs), however, home buyers can put their down payments to work as investments (AIMS also are known as annuity mortgages). The organization responsible for creating AIMs is marketing the loan as an option for home buyers who would rather not rely entirely on the appreciation of their property to build equity.

AIMs work by combining a traditional fixed- or adjustable-rate mortgage with a tax-deferred fixed annuity. If a borrower obtained a $200,000 mortgage, for example, he or she usually would put down 20 percent, or $40,000, toward the purchase of a house. With an AIM, only $10,000 would go toward the purchase of a house as a down payment. The remaining $30,000 would be invested in an annuity and earn tax-deferred interest. The principal amount in the annuity would be considered collateral against the mortgage until the borrower either repaid the loan or sold the house.

Mortgage payments on a $200,000 AIM would be based on a loan of $190,000, not $160,000, resulting in higher monthly payments. But AIM advocates say that over time the annuity could increase in value enough to help the borrower repay the mortgage sooner. Or, the annuity could provide income for a variety of other needs, such as retirement or education.

The annuity portion of an AIM would provide increased liquidity - subject to the normal withdrawal restrictions associated with this product. In contrast, when a full down payment is made on a house, a borrower would be forced to sell the house or obtain a home equity loan in order to access the home's appreciated value.

A major advantage of annuity mortgages is that a borrower can hedge against falling real estate values. The annuity will continue to grow even if the value of the house does not. A borrower also will be offsetting the total cost of his or her mortgage with interest earned on the house's down payment. An AIM also could benefit those who have trouble saving or who are not contributing to another tax-deferred investment.

Under the terms of an AIM, borrowers lock money into an investment whose yield may not remain competitive over time. Most fixed annuities guarantee a minimum interest rate, such as 4 percent. If a borrower is disciplined enough to invest beyond the mortgage payments being made, the result could be the same as using an AIM to finance the acquisition of a house. Exact comparisons are difficult, however, because an annuity will grow tax-deferred. And if a borrower decided to cash in all or part of the annuity early, he or she would face a 10 percent Federal tax penalty on the accumulated interest if the borrower were younger than 59 1/2.

The Federal National Mortgage Association (Fannie Mae) has begun including annuity mortgages among the types it purchases from mortgage companies. But the annuities must be issued by AAA-rated insurance companies that have been approved by the lenders and Fannie Mae.

So far, AIMs seem most popular among high-income individuals who can benefit from the larger mortgage interest deduction, while allowing the annuity to grow tax-deferred, and parents or grandparents who are helping their children buy houses. Parents or grandparents can provide funds for a house's down payment and eventually get repaid from the annuity balance.

William G. Kistner, CPA, is a tax partner with Ernst & Young LLP, Chicago, Illinois. Readers' comments and questions should be addressed to him at Ernst & Young LLP, 233 S. Wacker Drive, Chicago, Illinois, 60606.