The new generation of mortgage products - Wealth Builders

Chief Executive, The, Nov, 1995 by Joseph L. McCarthy

Your parents probably told you that the best investment you could ever make would be to own your own home. That may have been true when annual, double-digit upticks in real estate value were practically automatic, but a decade ago, the balloon popped, leaving investors of all income strata scrambling for alternatives. These days, buyers are more realistic about the role a home plays in a broader investment portfolio. And mortgage brokers and other financial institutions are whipping up a bewildering range of new products to give investors maximum flexibility. What's clear is that the tax deductibility of interest on a home mortgage figures as perhaps the last significant tax deduction. And the higher the tax bracket, the bigger the deduction.

Private banks and commercial institutions alike will move mountains to customize a product such as a jumbo mortgage to meet your needs. Outside jumbos, one new product enables buyers to sock away all or part of a down payment on a home in investment vehicles such as variable and fixed annuities, and in life insurance policies. At least with the life insurance variation, a down payment earns tax-deferred interest, providing a chance to lower the cost of your loan by 20 percent or more.

"Why let the single largest payment you'll ever make sit there as dead equity?" asks Preston Martin, chairman of San Francisco-based HomeVest Financial Group, which created the life insurance-based, or "combined asset," mortgage. "There's tax-deferred buildup and the ability to borrow against the policy at net zero cost with no fixed repayment schedule."

Here's how the HomeVest CAM works: Let's assume a 40-year-old, married, non-smoker with an annual income of $170,000 and in a 40 percent tax bracket seeks to buy a home priced at $600,000. Let's say the buyer puts down 20 percent, or $120,000, financing the remainder through a 30-year, fixed-rate mortgage at 8.375 percent, in which the payments would be $3,648. With a CAM, you might put that $120,000 into a life insurance policy with a projected rate of return of approximately 6.25 percent and a guaranteed rate of 4 percent. Your loan would be for $600,000, because you still have to pay the seller the balance, and you would have higher monthly payments of $4,645. But over time, says Martin, a former vice president of the Federal Reserve Board of Governors, the appreciation from the life insurance policy would offset your total costs. After 30 years, at the higher projected rate of return, your after-tax financing cost with the HomeVest product would be $655,654, compared with just $500,043 with a traditional mortgage. But if you deduct the available cash in the life insurance policy at the end of the period, $494,485, less the initial $120,000, your total financing cost would be $161,169 - a savings of nearly $339,000. Even at the minimum 4 percent rate of return, you would save nearly $70,000.

HomeVest remains the only broker to offer the CAM, although other institutions are experimenting with similar products.

What's the downside? Given the higher cost of the HomeVest mortgage, it may take up to seven years before the life insurance policy appreciates enough to provide a financial benefit, says Larry Hughes, first vice president for The Boston Co., an institution that is exploring the possibility of offering the HomeVest product. Moreover, points out HomeVest CEO Dan McConnell, high-end buyers - those purchasing a home for $500,000 or more - may find themselves "buying a lot of life insurance."

Obviously, it's harder to project the cost or benefit of the variable annuity version of the product. These are offered by institutions including Hamilton Financial in San Francisco and Inland Mortgage in Indianapolis. The fixed and variable products, known as asset-integrated mortgages, or AIMs, work in roughly the same way as CAMs, Martin says, although the IRS ruled recently that interest payments on annuity-based mortgages were not tax deductible.

Hughes of TBC, which handles the jumbo mortgage business of Mellon Private Asset Management, a unit of Pittsburgh-based Mellon Bank, points out there's also tremendous flexibility in the jumbo mortgage arena - defined as home-mortgage loans of $250,000 and up. (The current rates on jumbos hover from 4.99 percent to 8.25 percent.) Some loans offer a 10-year, interest-only period. Some institutions allow buyers to use securities they own as collateral, avoiding capital gains tax on a liquidation.

What's the bottom line? Everything's negotiable when it comes to jumbos and other mortgage products popular among high-net-worth people, says one veteran private banker based in New York. "Don't be afraid to shop around."

Joseph L. McCarthy is a contributing editor to CE.