Today, Dr. Don explains the moving treasury average and discusses ways to avoid paying PMI.

Treasury Terms

Dear Dr. Don,
I know that "MTA" stands for moving treasury average, but what does it mean? I would also like to know where I can find the history of this index for the past two years. I've tried using the Federal Reserve site but find it very confusing. Is this index also known by other names (treasury constant maturity, T-bill weekly auction, etc.) and how long has it been in use?
Bob Bothered

Dear Bothered,
I've seen it defined as both moving treasury average and monthly treasury average. The 12-month MTA is an adjustable rate mortgage index. The use of this index for ARMs is a recent development and the product is not widely available. The index averages the previous 12 monthly values of the 1-Year constant maturity treasury. So the index is a moving average based on monthly observations. Moving averages will trend higher or lower along with changing interest rates but don't spike up or down. This smoothing attribute of a moving average reduces the homeowners' need to time the market when borrowing using an ARM based on this index. The index is sometimes referred to as the 12-month moving average treasury, or 12 MAT for short.

Three-month and six-month treasury bills are auctioned weekly. The one-year treasury bill has been auctioned monthly but the Treasury is planning to auction that bill less frequently. Constant maturity treasury yields aren't actual government debt, but are a calculation of the expected interest rate for a particular maturity at a certain time. The Federal Reserve Bank of St. Louis can provide you with the monthly one-year constant maturity yields. Use our Watch Market Rates page to follow interest rates.

Another site with a well-presented page of indexes is at Mortgage-X.com.

Alternatives to PMI

Dear Dr. Don,
I am trying to avoid private mortgage insurance costs related to buying a new house. Which is the best option in providing about $40,000 to cover a 20 percent down payment?

1. Borrow against my work 401(k) plan.
2. Sell off securities and take capital gains hit.
3. Set up short-term line of credit with a local bank and pay it off in five to 10 years.

Davis Downpayment

Dear Davis,
There are a lot of ways to structure the purchase of your home to avoid paying private mortgage insurance. The first mortgage lender will require PMI if the mortgage is more than 80 percent of the appraised value of the home. So to avoid PMI, you have to raise enough cash outside the first mortgage to keep the loan-to-value at or below 80 percent.

The most popular way to avoid PMI is to take out a second mortgage at the same time that you take out the first mortgage. The structure of the two loans can vary but a common structure is 80-10-10. That means that there is a first mortgage of 80 percent, a second mortgage of 10 percent and a cash down payment of 10 percent. Many primary lenders also will lend you the second mortgage, which streamlines the process. This approach is better than a short-term line of credit because the interest expense on a second mortgage will generate tax savings for most homeowners.

Borrowing against your 401(k) plan is an option, but for many people it derails their investing for retirement because they stop making new contributions to the plan while they are paying the loan. Changing employers also can trigger a repayment provision, requiring you to pay off the loan. You do pay yourself interest on the loan, but for most people that's a lower return than they are averaging on their 401(k) investments.

Instead of selling your securities in your taxable accounts, you could pledge them in lieu of a down payment. A security pledge requires you to set up a separate account and the assets have to be worth about twice the 20 percent down payment. In your case you would need to pledge about $80,000 in stocks and bonds. That gets the lender where they want to be on a risk basis, and allows you to continue to realize the return on those pledged securities. If the value of your investments fall, you will be required to pledge additional securities. You can trade the pledged stocks and bonds, but there are parameters on what securities can be pledged. Tax-deferred investments such as those held in your 401(k) plan cannot be pledged. Brokerage firms that have a real estate lending arm will be able to structure this mortgage loan for you. Merrill Lynch does this type of mortgage lending. For a good story on how this works, check out this recent Bankrate.com story: Use stocks to finance your home

Which way should you go? My last resort would be to borrow against the 401(k). Instead, have a lender discuss an 80-10-10 or similarly structured loan with you so you can get a sense of what the interest rate would be on the second mortgage. Just don't get so wrapped up in the quest to avoid paying PMI that you forget to consider the higher interest rate and fees associated with the second mortgage. A primary mortgage with PMI can be competitive and PMI doesn't last forever. And if your taxable portfolio is large enough to consider pledging securities, then talk with a brokerage firm about that product.

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-- Posted: April 5, 2000