What if I told you could get a $200,000 mortgage at a 1% interest rate, with a minimum monthly payment of $643 per month!? And your payment would only adjust by about $50 per year no matter what the market does! Sound familiar? Too good to be true? (recall mother’s advice: “If it sounds too good to be true . . . it probably is.”)
If you have heard or read this before, most likely they are talking about an MTA loan. Here is why this loan is anything but “Optimus” for your home financing. The loan and monthly payments start out well-and-good but quickly ‘transform’ into something very different. Kind of reminds me of that time when Megatron was leading the Decepticons in their villainous plight to take over . . . (sorry, I have taken the Transformers analogy MUCH too far!! nerd alert!! nerd alert!!)
MTA stands for Monthly Treasury Index. This type of loan (generally named an MTA loan, a Pay-Flex loan or a Pay-Select loan) is a one month adjustable rate mortgage based on the MTA index. The MTA index is an index calculated based on the twelve month average of annual yields on actively traded US Treasury Securities — the Monthly Treasury Average Index. Because this index is an average of the previous twelve months, it is a much slower moving index than all other adjustable rate mortgage indices. For more information on adjustable rate mortgages (ARMs) and how they adjust, check out my previous post.
This loan does in fact have a rate of 1% . . . a “start-rate” of 1%. Based on the example above, the first month’s payment (of principle and interest) would be $643 per month. However, after the introduction period (usually a 1 month or 3 month period), the interest rate adjusts to the “real” interest rate = the MTA index plus a margin. The margin on this type of loan can vary between programs, but for the sake of this post, I’ll use 2.75%. With the MTA index currently sitting at 4.664 (as of September 9th), the “real” or fully-indexed rate would be 7.414%. Ouch! And to make matters worse, unlike most ARMs, this loan usually does not have a cap on adjustment (although it may have a life-time cap of 10% or so). Ouch again!
So what about the payment only going up $50 per year?
Here is where the loan gets even more confusing. The loan is called a “Pay-Flex” loan because it is sold to consumers with the idea that you have the flexibility to make one of four payments. You can make the minimum payment, an interest-only payment, a 30 year amortization payment or a 15 year amortization payment (the last two options are laughable at best). The consumer can select (hence the name “Pay-Select loan”) which option they want to pay. What a friendly loan!?? Just make whichever payment you like, no problem . . . not a problem if you like paying more interest of course.
In the example above, the payment (the minimum payment) will only increase by 7.5% per year. So if the first year’s payment (minimum payment) is $643 per month, the second year’s payment (minimum payment) will be $691. However, because the interest rate has adjusted up, the difference between the minimum monthly payment and the interest for the month . . . read carefully . . . will be added to the loan balance. So, for a $200,000 mortgage balance, now at a rate of 7.414%, the interest for one month would equate to $1,253. The minimum payment would be $592 TOO LOW even to cover the interest on the loan and that amount would be added to the loan balance (called negative amortization). Next month’s interest payment would be calculated on a new loan balance of $200,592. This cycle of adding to the loan balance would continue until the loan value had maxed-out at 115% of the original appraised value.
Bottom line, compared to an intermediate adjustable rate mortgage (a loan that is fixed for a set number of months or years like 3, 5, 7 or 10, and then converting to a 1 year ARM with caps on adjustment), now available — and extremely popular — with an interest-only payment, the usefulness of an MTA loan is pretty slim.
There may be one small argument that would say that because this loan adjusts as the market adjusts, a consumer will reap the benefit of falling interest rates (and a falling MTA index) automatically without the hassle and expense of refinancing, but it would be a pretty tough argument to make. If you looked at the average of the MTA index over the past 10 years (3.973 — which would equal a mortgage rate of 6.73%) and over the past 5 years (2.503, which would equal a mortgage rate of 5.25%), someone might make a mildly convincing argument.
But, if somone made the argument so compelling to you (especially at the beginning of 2004 when the MTA index was at it’s lowest point and the adjusted rate was 3.975%) now that things have transformed for the worse and the rate has gone up to 7.375%, and your interest-payment has gone from $662 per month to $1,229 per month, you might just wish you had a 30 year fixed rate loan at 5.25%.