Mortgage Rate Falling? Here’s Why

Q. I have an adjustable-rate mortgage tied to the 11th District cost of funds. I know interest rates have been rising lately, causing a corresponding increase in adjustable mortgage and bank card rates. However, the 11th District cost of funds has not been rising. I even expect my mortgage rate to drop when it is adjusted later this month. What’s going on? --M.H.

A. You are not alone in wondering about this matter. Since the early 1980s, when adjustable-rate mortgages became common, the otherwise little-noted 11th District cost of funds index has come under a lot of scrutiny whenever interest rates move one way and the index moves in the other direction.

The simple answer is that the 11th District index is considered a “lagging indicator” of economic activity. It rises more slowly than other indexes and falls more slowly as well. Lenders estimate that it typically trails by two to three months changes in the interest rates being paid to purchasers of 12-month U.S. Treasury bills.

To understand why this is possible, you have to understand what the index is and how it operates. The index is the weighted average cost of all funds deposited in 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.

Because the index includes both long-term and short-term borrowings, it is considered far less volatile than other measures of the cost of money. For example, an analysis prepared for Great Western Bank shows that in August, 1981, when the prime rate was approaching 21% and the interest rates being paid on 12-month Treasury bills exceeded 16%, the 11th District index reached only 12.029%.

The district computes the index monthly and publishes the figure for a particular month on the final working day of the next month. The rate for March, 1994, reported two weeks ago, was 3.629%. Adjustable-rate mortgages tied to the 11th District index typically run about two to four points higher than the index. The difference covers lenders’ overhead and profits.

Interest rates have been steadily rising since early February, when the Federal Reserve Board set off a ripple effect by raising a key lending rate between banks. For example, rates for new, 30-year, fixed-rate mortgages have jumped more than 1 1/2 points since then. The current average is about 8.5%.

If your adjustable-rate mortgage is reset annually according to the 11th District index, it is conceivable--even likely--that your mortgage rate will drop this year. For example, mortgage rates adjusted as of the March index would enjoy a drop of more than 0.6 percentage point, because the index declined from 4.245% in March, 1993, to 3.629% in March, 1994. Rates adjusted as of April and May this year may also go down.

The current 11th District rate is available on a taped telephone message to callers from California, Arizona and Nevada at (800) 283-0700, ext. 2600. A brochure on the subject can be ordered from the Federal Home Loan Bank of San Francisco, Communications Department, P.O. Box 7948, San Francisco, CA 94120.

To Avoid Penalties, Borrow From 401(k)

Q. Is there any progress being made toward eliminating the penalties on early withdrawals from 401(k) plans when the funds are used to purchase a family’s first house?

We withdrew about $30,000 from my husband’s 401(k) plan this year and are paying penalties and taxes that will consume about 40% or more of the money. Is there anything we can do? --D.S.

A. Although Congress has talked for years of changing the rules surrounding use of 401(k) funds for home purchases, so far the plan has not progressed much beyond the discussion stage. And, given the concern over the federal deficit and Uncle Sam’s seemingly insatiable need for cash, it is unlikely the government will wipe out this source of revenue in the near future.

Buying a house with your 401(k) funds qualifies as one of the “hardship” justifications a taxpayer can invoke to make a premature withdrawal, but the penalties--10% to the federal government and an additional 2.5% to the state of California--remain. In addition, the withdrawn funds are subject to ordinary state and federal income taxes. (Although the exact amount of income tax owed is computed when you file your return, early withdrawals are subject to an automatic 20% federal income tax withholding.)

Although it is too late for you, others in your situation should consider borrowing against their 401(k) accounts as an alternative to withdrawals. Check with your employer to determine if your company permits such loans; not all do.

There are limits as to how much you can borrow against a 401(k) account before the loan is considered a taxable withdrawal. In general, the IRS and the Department of Labor allow borrowing up to 50% of the account balance, up to a maximum of $50,000.

By the way, the interest you pay on such a loan is not tax-deductible. Your loan is considered a personal one for which you have pledged your 401(k) account funds as collateral.

Date of Death Fixes Worth of Bequest

Q. I understand that the tax basis of inherited property is its value on the date of death of the donor. What happens if the asset left by the deceased has lost value since its acquisition? --A.G.B.

A. Assets bequeathed at death are valued as of the donor’s death, regardless of whether they are worth more or less than the donor paid for them. Recipients have no choice in the matter. Why would Uncle Sam want to give a recipient the right to claim a loss he never really suffered?