Analyzing CMG's early-mortgage-payoff program

Two years ago I wrote a fairly critical piece about CMG Financial’s Home Ownership Accelerator (HOA) loan program that did not do it justice. HOA is fairly complicated and this time I took a harder look.

HOA is a permanent mortgage that has some features found only in a demand deposit account at a bank and other features similar to those in a home equity line of credit (HELOC), except better.

HOA as a Deposit Account: An HOA can be used as if it were a checking account. A borrower’s paycheck, instead of being deposited in a bank account to earn little or no interest, pays down the mortgage balance. The borrower thus earns the mortgage rate starting the day of deposit.

As the borrower spends money by writing checks, withdrawing cash from an ATM or using a bill-pay service, the mortgage balance rises. Even if the balance at the end of the month is the same as at the beginning, the average balance — and therefore the interest charge — is lower.

HOA as a Line of Credit: Both HOA and a home equity line of credit (HELOC) accrue interest daily, and adjust the interest rate frequently — monthly on the HOA, anytime on the HELOC. Borrowers can draw up to a specified maximum amount at any point during an initial 10-year draw period, with repayment required over the ensuing 20 years.

But there are important differences. HOA is a first lien and is used to purchase properties and to refinance existing loans. A HELOC is usually a second lien and is used for other purposes, such as home improvements and consolidating other debts. A HELOC cannot be used as a deposit.

Perhaps the most important difference is that an HOA borrower has no required payment and can even withdraw funds during the repayment period, so long as the current balance is below the maximum balance. A HELOC borrower must make a payment every month and cannot make withdrawals during the repayment period.

The HOA maximum is unchanged during the first 10 years, unless the borrower exercises a one-time option to increase it. During the 20-year repayment period, the maximum balance declines every month by 1/240th of the amount at the beginning of the repayment period.

The interest-rate risk is also much lower on the HOA. The maximum HOA rate is 5 percent over the initial rate, whereas HELOCs have no contractual maximums; they are constrained only by state usury ceilings, which range from 18 percent to 24 percent.

HOA as a Permanent Mortgage: HOA is an adjustable-rate mortgage (ARM) with monthly rate adjustments. Monthly adjustments make the HOA more sensitive to market changes in both directions than hybrid ARMs on which the initial rate is fixed for two to 10 years.

The HOA rate is fully indexed, meaning that it equals the current value of the rate index plus the margin, starting in month 1. The margin is 2.25 percent, which is a common margin on prime hybrid ARMs. The index was about 5 percent in October, making the HOA start rate about 7.25 percent. This was well above the start rate on hybrid ARMs.

However, HOA borrowers can get 90 percent loans (10 percent down) without paying for mortgage insurance. Further, for 2.75 points, borrowers can buy down the margin from 2.25 percent to 0.75 percent, which would reduce the start rate to 5.75 percent. This is a bargain, even if you pay off your loan very quickly. Every HOA borrower should buy down the margin to 0.75 percent.

Assuming you buy down the margin and take a 90 percent loan, the cost of an HOA is not much different from other ARMs that do not offer the same advantages.

HOA as an Early Payoff Tool: HOA is overhyped as an early payoff tool, because the prospect of paying off early captures people’s attention. However, while the intra-monthly interest savings described earlier are real, they don’t add up to much. To pay off a 30-year loan in 10 or 15 years requires extra payments, and you don’t need HOA to make extra payments. The flexibility of the HOA, however, makes it easier to save.

HOA as a Flexible Planning Tool: Flexibility is the major virtue of the HOA. Borrowers with money that they might use to pay down the mortgage but don’t because they might need it again don’t have to make that choice. They can use it, and if they need it again, they can draw it out. Borrowers with highly unstable incomes can make a large payment when they are flush, and skip making payments when they are not.

HOA is a mortgage for responsible adults. You need a FICO score of at least 680; you need not escrow taxes and insurance; and you must put 10 percent down.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.