- The Washington Times - Friday, July 25, 2003

If you want a really, really low rate on a mortgage, you can find it with three adjustable-rate mortgage (ARM) programs: the Cost of Funds Index (COFI), the Cost of Savings Index (COSI) and the Certificates of Deposit Index (CODI).

How does a 2 percent loan sound? Great, doesn’t it? Well, there’s always a catch, and here’s the minimum amount of information consumers should understand about these three ARMs that plenty of buyers and investors are using to get lower monthly payments. The interest rates on these three programs are superlow. The index as of July 1 was 2.130 percent for the COFI, 2.140 percent for the COSI and 1.419 percent for the CODI.

The total index would be the above-mentioned rates coupled with the “margin,” which is added onto the index rate to provide the total interest rate. When added, the “fully indexed” payment would come up to about 3 percent to 5 percent, depending on the margin.

There’s a possible bite to be aware of when using these indexed loans, and I’ll tell you about that in a moment. First, a brief description of each.

The COFI historically has been the slowest moving index in the United States and Europe. Each month, it allows borrowers to select from one of several payment amounts: a superlow minimum payment, much like a credit card; an interest only payment; a fully indexed loan, as described earlier; a payment equal to a 15-year term payment; or an amount the borrower determines over the minimum payment.

It can be a complex loan to understand, and that’s why a lot of buyers avoid it. Many of my investor friends like it, however, when purchasing rental properties or properties they want to fix up and sell quickly. The payments are very low, which preserves their cash flow for the short term while they’re refurbishing the property.

The COSI program is tied to the average interest rate paid out to consumers, known as the “cost of savings.” In layman’s terms, the lender borrows money from consumers in the form of deposits, such as certificates of deposit (CDs), checking and savings accounts, etc., and turns around to lend the money to home buyers and homeowners as mortgages. Again, the rate is very low and a margin is placed on top of the index.

Have you seen what you’re getting in your interest-bearing checking account lately? The 11th District takes all of its banks’ interest payments on such accounts and determines an average cost of savings — through a weighted annualized rate on these deposit accounts as of the last day of each month. And now you know why a lot of people don’t know about this loan — it’s just so darned complicated.

Nevertheless, historically, the COSI’s fluctuation has moved a lot less rapidly than indexes based on the prime rate (the rate you hear about every month from Federal Reserve Board Chairman Alan Greenspan), the Federal Reserve discount rate, or the Treasury bill rate (the most popular one-year ARM index quoted by the general media).

I would like to explain to you why the COSI Index moves so slowly, but the good editors I work with limit how much I’m allowed to write. Suffice it to say, bean counters who graduated a lot higher in their classes than I came up with a formula to determine the index and margins that provide consumers with a really low rate from which to choose.

Trying to understand it before using it is like trying to understand electricity before flipping on the light switch. I encourage you to conduct due diligence on this index before deciding to use it for your home purchase.

Finally, the CODI Index. This one is also based on the rates banks pay on three-month certificates of deposit. This index is based on the average of the most recently published monthly yields on three-month certificates of deposit for the 12 most recent calendar months as published by the Federal Reserve Board.

The formula involves something like annual percentage averages, divided by 12 and rounded to the nearest one-thousandth — so, again, you can imagine the complexity of how these interest rates are determined and why they are not commonly used loans.

Because of its smaller pool of money to loan out, the CODI programs’ margins are slightly higher than the COFI or COSI indexes.

Now — here’s the bite. If you make the minimum payments allowed with these loans, a borrower could find himself in a negative amortization situation. That’s a mouthful for — your loan amount grows instead of shrinks.

It works just like a credit card payment would if you paid only the minimum amount — except this time, the interest rate keeps changing each month. In a worst case scenario, you could wind up not even paying the interest each month resulting in a growing balance. Your only hope, if you hang onto the loan for a long time, is that the appreciation on your home will outpace the ebb and flow of the COFI, CODI or COSI’s index and margins.

I have had a COFI loan before, and it allowed me more purchasing power. I held it for more than five years, and I’m not the poorer for it. However, be sure to get a handle on what it means for your financial standing before applying for it.

For more information, talk with your loan officer or visit the Federal Reserve Bank Web site at www.FederalReserve.gov.

M. Anthony Carr has written about the real estate industry for more than 15 years. He can be contacted at [email protected]

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