A lender who rewards good behavior as much as it punishes bad? A mortgage company that slashes its customers' payments automatically? Yeah, right.

Actually, it is. A handful of mortgage companies now drops rates for their borrowers when interest rates fall. Some home equity lenders do the same for customers with less-than-perfect payment histories who send their checks in on time.

Taken together, these developments suggest people will increasingly find themselves able to cut their debt without experiencing the hassle -- and financial burden -- of refinancing.

"We notify all of our customers when the rate has dropped and encourage them to drop the rate," says James Riley, chief executive officer at City Line Mortgage Corp. of San Diego. The company offers its "Declining Rate Loan" to conventional borrowers in 15 states.

'Easy, logical thing'
"If their rate is lower, then nobody else can take that loan away from us," he adds. "It's such an easy, logical thing, it's unbelievable."

Unbelievable indeed, considering financial institutions seem to be much busier lately coming up with $29 credit card fees, $2 ATM surcharges and penalties for visiting tellers on every third Friday, excluding those that fall during a leap-year February. But thanks to some prodding from consumer advocates and a bit of innovative thinking among certain lenders, rate reduction programs are becoming more widespread.

"We're almost like the test case, but we've had tremendous success," says Keith Kelly, division manager for Fairfax, Va.-based Service Savers. The company's "Automatic Rate Cut" loan requires borrowers to pay a slightly higher interest rate upfront. But it allows them to avoid closing costs and gives them the chance to lower their rate every 120 days each time market rates decline by a quarter of a percentage point or more.

"Ours is primarily different because we're trying to give the consumer peace of mind," he adds. "They're getting inundated every week in a refinance boom, both in the mailbox and at dinnertime. But from the start, ours is designed to educate the consumer on why they should never pay closing costs, and then to automatically contact them when they can actually save money."

A popular concept
It's unclear exactly who first thought of the adjusting mortgage concept, but it has clearly been a popular one. As more companies and consumers become aware of it, the pace of its acceptance has picked up, too.

Service Savers, for example, had been offering its program to refinancing borrowers for a few years. The company opened the program to home purchasers this August in response to consumer demand. City Line, which rolled out its loan a year and a half ago, says it's now getting inquiries from top U.S. lenders about the program's details and viability.

On the home equity and subprime loan fronts, the story is pretty much the same.

The Money Store division of First Union Corp. is among the biggest companies in the subprime industry, which specializes in lending to customers with imperfect credit. It introduced what it calls the "Back on Track" mortgage in September 1998. Now, the unit says that roughly 30 percent of its retail business comes from the special loans, which let borrowers shave up to 1.5 points off their interest rates over the course of four years by sending their money in on time.

Government officials have gotten behind the idea as well. In a March statement, Office of Thrift Supervision Director Ellen Seidman indicated she'd like to see more companies offering what her agency nicknamed the "Track Record Adjusted Mortgage." And after a years-long legal brawl with the Neighborhood Assistance Corporation of America over its lending practices, that's exactly what Associates First Capital Corp. agreed to do.

The massive Irving, Texas-based consumer finance company said in May it would make a rate reduction loan available to low- and moderate-income borrowers as part of a settlement it struck with the Boston activist group. On July 1, it expanded the "Freedom Loan" program so that anyone who wanted to apply for it could.

"We thought there might be some really nice appeal across our entire portfolio," says Associates spokesman Randy Johnson. "It really offered a lot to our customers and we also felt comfortable it would work from a business perspective.

"It's an inclusive type of program."

Will others join the party? Some experts seem to think so, especially if a secondary market for declining-rate mortgages emerges the same way one has for old-fashioned fixed- and adjustable-rate ones. In the meantime, borrowers can try shopping with one of the companies already offering them -- or pestering their own lenders into doing the same.

"I think there's a lot of misconception out there" about the concept, says Kelly from Service Savers. "It's not necessarily the fault of loan officers in banks, it's just the old school of thinking."