Biweekly Mortgages Enter the Market

Consumer lending faces new challenges

By Eric J. Christeson

The lending industry has entered an era of major challenges.

Technology, tax laws, reporting requirements and deregulation are promoting thrifts, Savings & Loans, banks, credit unions and mortgage companies to reevaluate their internal operations to comply with consumer and institutional demands for efficient and profitable financial services.

The loss of most of the instalment credit tax deductions on loans other than first and second mortgages is putting additional pressure on lenders to profit from mortgage loans, and for auto and major appliance companies to offer lower rates and other incentives to move their products.

These changes have made consumers more inquisitive and concerned with the financial implications of their purchases, and institutional investors more wary of the specific details of loan portfolios they purchase.

Change from technology

Technology has brought the ability to lenders to effectively scrutinize and manage their portfolios, and also to make their personnel more productive. This technology has simultaneously led the government to demand more specific reporting requirements and investors to scrutinize their investment alternatives.

One of the major new products being offered by many lenders in this environment is the biweekly mortgage, which offers consumers an effective way to pay off their loans in about 20 years instead of 30, saving several thousand dollars in interest.

Lenders find this product a good way of cutting collection costs, as the loans are made only with automatic deductions from the consumer's checking account every 14 days. More on this later.

Portfolio management

As mentioned above, portfolio management is the major new operational challenge facing lenders. Credit cards, savings accounts, unsecured lines of credit, first and second mortgages, and major loans for cars, boats, furniture and appliances are now being more carefully evaluated for profitability by pension funds and insurance companies before they invest.

It isn't fashionable anymore to say you have a $10 million or $60 million portfolio and that its overall profit is 10 percent. Now you must break it down by type of loan, know how to check and monitor the costs and profitability of each, and evaluate how overhead costs are affecting the profitability.

Douglas McEachern, a partner at the Big Eight accounting firm of Touche Ross, specializes in banking and finance. He made his point on evaluation by saying:

"you can no longer leave loans on autopilot."

According to McEachern lenders must know, in detail, the following about their portfolios:

What is the collateral?
Where is it located?
What is its present and future value?
Can financial disclosures be given on each item?

This is especially true for mortgages. Investors want to know exactly where the homes are located to evaluate the present and future values. Each community is different. McEachern stated that some lenders are unable to break out these facts and are also unable to determine cash flow, caps on interest rates and timing of repricing on a quarterly, semi-annual and, in some cases, even an annual basis.

"Collateral is top priority for pension funds, insurance companies and banks looking to invest in a financial institution's portfolio," he said. "They are seeking to minimize their risks, but it's first up to the lenders to understand the risks. This can be done by fully utilizing computer technology to break out the details of the portfolio and set up internal monitoring controls."

The US government and FASB (Financial Accounting Standards Board) are closing in on lenders, requiring them to disclose market values of assets and the risk characteristics of loans and/or investment portfolios. Are you ready?

Accuracy -- S. O. P.

As this trend for more accurate reporting and monitoring becomes a standard procedure, it's essential for every lending organization to find its niche in the marketplace. You can't be all things to all people, and it's even more essential today in this technological environment to focus on your most profitable products.

Since mortgages are now the only real consumer loan with a tax advantage, it's essential to see how you can broaden your customer base to include this important product.

Before getting back to biweekly mortgages, it's crucial to stress that patience and organized planning are necessary for profitability. Computers and software are not magic, but powerful tools to help you achieve your goals. Many lenders have made the mistake of buying these high-priced items without thoroughly examining their internal operations and product base.

A critical eye on your operation

I strongly advise the following:

If you are operating on a manual system that works, proceed, otherwise fix it first. If the manual system doesn't work, a computer system will only make mistakes faster. Take inventory of those things you're doing right and then look to automation to make these things work faster to free your time for other projects to make your business grow.
Make sure your people contribute to any changes made. Get them involved, for they are the ones who will make or break you later. If they have invested time and energy into any new systems, they will be more likely to try harder to make them work.
Determine what part of your internal structure needs revising, which must be changed immediately and which can be looked at later. Make a "wish list" of those things you would like to add later and another list of things you refuse to tolerate.

If you do all this, it will be easier to determine the kind of automated system and software you need to best manage your operation smoothly and accurately.

Biweekly mortgage

One of the hottest new products on the market is the biweekly mortgage. Originally offered in Canada and then spreading to the US, this mortgage matches perfectly the needs of consumers and lenders alike.

The home buyer is rewarded by saving thousands in overall interest charges, an impressive reduction in the payoff period length, and both are achieved without the higher qualifying standards associated with a 15 or 20-year mortgage. There's no magic to the product: it's simply the result of making the equivalent of one extra monthly payment a year (26 payments). In addition, the principal on which interest is computed is reduced at least twice a month instead of once.

Example: A 30-year, biweekly $100,000 mortgage at 9.25% will pay the mortgage off in about 21 years instead of 30 and save about $64,000 in total interest. Not bad for the consumer!

And for you? With the right software package, you can virtually eliminate collection costs, as the consumer must sign a pre authorization to have the payments deducted automatically from his or her checking account every 14 days. Also, the home buyer must usually maintain a ready-reserve account. You benefit from the ability to maintain a better cash flow.

One of the obstacles to the biweekly was removed when Fannie Mae (the Federal National Mortgage Association) began purchasing biweekly mortgage packages. Now loan originators have a ready secondary market in addition to Wall Street.

Case history

We've been offering biweekly loan servicing systems for several years. One of our customers, the $750 million Minneapolis Employee's Retirement Fund, has had great success with the biweekly.

John Chenoweth, executive director, said,

"We started out with a $30 million biweekly program as an experiment, and our members went crazy over it. The first $10 million was oversubscribed in a matter of days. We feel the biweekly is the most imaginative program in the country -- no red tape, no bureaucracy and no overhead."

Chenoweth has about 18 percent of his portfolio in mortgages and has brought the servicing in-house.

"During the past couple of years, we've saved about $250,000 by servicing our own mortgages. The automated payment system is the key. During the first year we haven't had a single default, not even a one-month delinquency. No mailings, no coupons, no postage, no record-keeping. The computers do it all."

There are really no more obstacles impeding the growth of the biweekly as a profitable and efficient means to increase a lender's market mix. Consumers need to be aware of the product, and lenders should consider investigating the process as well as the convenience of the biweekly.

Technology has changed the way we think and do business. It is wise for all of us to maximize growth and profits while offering better products and services. Loan portfolios are your meals; technology and new products are the spices to help you enjoy working in a profitable and exciting new environment.

Eric J. Christeson, CPA, is president and founder of Los Angeles-based Dynamic Interface Systems Corporation, creator of LOANLEDGER and its family of microcomputer loan system software. The company was founded in 1972 and serves more than 400 lenders across the US.

Reproduced from Credit World, with permission from the
International Credit Association (ICA), St. Louis, Mo.

Dynamic Interface Systems Corporation
5959 W. Century Blvd., Suite 1200
Los Angeles, CA 90045 USA
Tel: (310) 568-4567
Fax: (310) 568-0740
email: info@loanledger.com

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