An ARM That Goes One Way: Down

An Adjustable-Rate Mortgage that only goes down? Sounds too good to be true. But that's what a Virginia startup is promising.

But first, the background. If you've refinanced your mortgage without paying closing costs, there's a good chance that you're still paying for the privilege, in the form of a "yield spread premium" (YSP) that ended up in the pocket of your mortgage broker.
During the boom, YSPs became the lifeblood of brokers' incomes, and provided a powerful incentive for them to refinance customers into new mortgages again and again in order to generate fees.

Borrowers often ended up paying higher interest rates than they otherwise qualified for, and landed in unsuitable mortgages. YSPs became so notorious for sabotaging borrowers that the Department of the Treasury has effectively recommended the proposed Consumer Financial Protection Agency ban them. And consumers aren't the only ones who lose out: mortgage-backed securities investors had to pay for the risk posed by stampedes of borrowers refinancing their mortgages every time interest rates dropped, which wiped out expected future interest payments.

Now a Tysons Corner, Va. company is betting that a bit of financial engineering can reincarnate the hazardous yield spread premium as a win-win for consumers, mortgage brokers and investors alike.
Mortgage Harmony Corp. has introduced the Harmony Loan, which gives borrowers the option of switching to a lower interest payment when rates drop, while sticking with the same mortgage. Earlier this month, 1st Commonwealth Bank of Virginia became the first financial institution to sell the product. As with a yield spread premium, borrowers still have to pay a higher interest rate in order to take advantage of the option – a hike of a half a percent or more. But instead of getting a fee for every refinance, the loan officer selling the mortgage gets paid a fixed annuity no matter how many times the borrower subsequently refinances.

Company cofounder and veteran loan officer Keith Kelly built the Harmony Loan around a patent he registered last year, and says his goal was to provide loan officers like himself with steady income while reducing risks to borrowers and mortgage investors. "Politically, there's a lot of pressure on lenders to figure out how to compensate loan officers over time and not up front," says Kelly. When mortgage brokers get fees for each refinance, he notes, "a lot of churning goes on. It puts the customer in the wrong product, just to get the commission."

As interest rates rise from their current lows, expect to see more products like Harmony Loan, which sell the upsides of adjustable rate mortgages and refinancings while limited risks for lenders and investors. Just remember – for a borrower, there's no such thing as a free refinance.
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