Making Sense of Adjustable Mortgages

QUESTION: Our adjustable-rate mortgage keeps increasing although it is based on the 11th District cost of funds, which has been stable for the last two months. My problem is compounded by the fact that the figure I see in the newspaper is not the figure the bank says is operable. My bank says the index is about 0.2 percentage points higher. How do I find out who is right?--Y. B.

ANSWER: You are not the only homeowner confused by the workings of the 11th District cost of funds, an otherwise esoteric measure of savings institutions’ cost of attracting deposits that came into the limelight in the early 1980s with the rising popularity of adjustable-rate mortgages.

First, a brief explanation of the index and how it operates. The index is the weighted average cost of all funds deposited into the more than 200 savings institutions in the 11th District of the Federal Home Loan Bank, a territory that covers California, Arizona and Nevada. Among the funds tracked are those in savings, checking and money market accounts, certificates of deposit and other bank instruments.

The interest rates of all these accounts are averaged to determine the index, a figure that represents the interest rate the savings institutions actually had to pay their customers to attract the money they now have available to lend.

The district computes the index rate monthly and publishes the figure for one month on the final working day of the following month. This is probably where your problem with your bank stems. Although we cannot be absolutely sure, the two-month lag often leaves room for confusion. For example, the index for December, 1989, which was announced last Wednesday, is 8.476%. This rate will be used for mortgages originating this month and for existing mortgages set to recalibrate with the rate in effect in February. But this is not the February rate. That number won’t be known until the end of March, and it won’t take effect until April.

To unravel your confusion, you should talk to your lender and make sure you understand which month of the year governs your mortgage adjustment. Perhaps your lender has made a mistake, or perhaps you don’t understand the terms of your mortgage.

But one thing is for sure: Your lender cannot arbitrarily and unilaterally alter the terms and conditions of your mortgage loan agreement. The month, the applicable index and the allowable margin over that index should be clearly set forth in your contract. So, if your mortgage rate is tied to the 11th District cost of funds in December, your basic rate would be 8.476, plus any margin above that base allowed by your contract. (Many agreements allow a lender to charge 2 percentage points, or more, above the 11th District index.) The current 11th District rate is available on a taped telephone message to California callers at (415) 393-1418.

Few Benefits From Selling Half of Home

Q: We are considering selling half of our current home, worth about $300,000, to our son and purchasing a new home for ourselves. The purchase price of the new home would probably exceed $300,000. I am over age 55 and my wife and I have lived in the house for 25 years. Because we are selling only a portion of the house, are we still eligible to take advantage of the $125,000 exclusion of our profits from the sale? Or if we can’t take the exemption, can we defer taxation on the capital gains from the sale by buying a new house?--R. H. R.

A: Our tax experts consider your plan innovative, but--unfortunately--illegal. Basically, you’re not selling your principal residence; you’re only selling half of it. And that leaves you unqualified to invoke either of the two tax-sheltering advantages otherwise available to you: the $125,000 exclusion available to home sellers age 55 or more and the deferral of gain by purchasing a replacement principal residence.

So if you elect this option, you would be liable for taxes on whatever profit you realize from the sale, an amount that you would calculate by deducting half your cost basis in the house from your sales proceeds. Remember, your cost basis is determined by adding the costs of any capital improvements you made to the house to its original cost.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.