11th District Rates Slow to Change
QUESTION: I have an adjustable-rate mortgage tied to the 11th District cost of funds. Periodically, I notice that this rate is going up quite rapidly while other rates, including fixed-rate mortgages, are coming down. Why, when long-term rates on T-bills are declining, is the 11th District cost of funds rising? If this continues, it will cost a lot of people, including me, a lot of money since our mortgages are tied to this index.--N. A.
ANSWER: Your concerns have a familiar ring. Since the early 1980s, when adjustable-rate mortgages became common, the otherwise-esoteric 11th District cost of funds index has come under a lot of scrutiny.
The index is the weighted average cost of all funds that flow into savings institutions in the 11th District of the Federal Home Loan Bank, a territory that includes California, Arizona and Nevada.
Among the funds tracked are those in savings, checking and money market accounts, certificates of deposit and other bank borrowings. The interest rates paid on all these accounts are averaged to determine the index--which reflects what the savings institutions actually had to pay their customers to attract the money they now have available for loans.
The district computes the index rate monthly and publishes it on the final working day of the month. Adjustable-rate mortgages typically run about two to three points higher than the index, a difference designed to cover the lenders’ overhead costs and profit margins.
Because the index includes both long- and short-term borrowings, it is considered far less volatile than other measures of the cost of money. For example, another popular index in some parts of the country is the one-year “constant maturity” Treasury rate.
This index is the U.S. Treasury’s estimate of the effective yield on all outstanding Treasury securities with one year left to run, regardless of when they were issued. The effective yields on these notes reflect current short-term market interest rates--not the rates prevailing at the time the notes were issued. Hence, their greater volatility than the 11th District index, which includes long-term as well as short-term borrowings.
For example, an analysis prepared for Great Western Savings shows that in 1981, when the prime rate reached nearly 21%, the one-year Treasury rate exceeded 16%. But the 11th District index reached only 12.67%.
However, just as the 11th District index rises more slowly than other indexes, it falls more slowly as well. Lenders estimate that it typically lags from two to six months behind the one-year Treasury rate. The latter index has gradually fallen about 0.5 percentage points to 6.99% between September, 1987, and January, 1988. Meanwhile, the 11th District index fell for the first time in nearly a year in January, when it hit 7.615%.
The current 11th District rate is available on a taped telephone message to California callers at 1-800-824-6560. A brochure on the subject is available from the Federal Home Loan Bank of San Francisco, Communications Department, P.O. Box 7948, San Francisco, Calif. 94120.
Q: I bought my residence on the basis of a seven-year loan from the seller with a zero interest rate. Obviously, the zero interest was in lieu of a discount on the original price of the home. The zero interest was subsequently used as a successful argument in getting a reduction in property taxes.
A tax adviser told me that I could deduct imputed interest based on small business law, which was said to apply equally to individuals. But the company collecting my mortgage payments for the seller told me that they would report zero interest to the IRS and that I was not entitled to deduct any mortgage interest on my income taxes. Am I, or am I not, entitled to a mortgage interest deduction?--B. G.
A: The IRS says you are entitled to a deduction for “imputed interest.” But determining what portion of the sales price of your residence was paid in lieu of interest isn’t going to be easy, and the IRS strongly recommends that you consult a qualified professional to handle the computation.
You should also realize that, by assigning a portion of the sales price to imputed interest, you are reducing the “tax basis” of your house, thereby opening yourself to the potential of reporting an even larger taxable gain when you sell it. For more information on the subject, refer to the discussion of “unstated interest” in IRS Publication 537, “Installment Sales.”
Q: Why is it that the free travel that frequent fliers receive is not taxed as income? It seems unfair that they should receive these free trips and not pay taxes as one would if he won a prize in, for example, a lottery.--V. W. S.
A: If it’s any comfort, you’re not alone in your opinion. There have been several serious suggestions in Washington during the past several years to tax the frequent flier bonus trips as winnings income. But each time the idea hasn’t gotten--pardon the pun--too far off the ground.
So far, proponents of these wildly successful airline promotions have successfully argued that they are bonuses distributed in lieu of offering discounts on the trips that the traveler already paid for.
The proponents would like you to think of these free trips like the old S&H; green stamps. Remember when merchants would give you these stamps and you’d collect them until you had enough to redeem them for a toaster, blender or whatever? Well, frequent flier trips--although more exciting--aren’t really any different in concept, their advocates say.
Airlines argue that they are not going to any extra expense to provide the bonus trips, since they are only filling otherwise empty seats on regularly scheduled flights. By the way, this is the same argument that the airlines use to support their contention that free travel passes for their employees should be considered an employee benefit, not taxable income.
