The Next Era in Mortgages? The Ratchet Mortgage™

A patent-pending financial product called the Ratchet Mortgage creates member value by capturing the benefits of refinancing, without transaction costs and traditional rate-shopping.


Fundamentals of the Ratchet Mortgage
A Ratchet Mortgage combines features of fixed-rate mortgages and ARMs to offer what is in effect a one-way ARM. It thus mimics the behavior of a rational borrower who refinances into a new fixed-rate mortgage when interest rates fall, but without any borrower initiative required and with no costs to the borrower. Because the rate adjustment is automatic, it is not contingent upon a borrower’s current credit score or any other qualification standard.

Benefits to Members
The Ratchet Mortgage is exceptionally borrower-friendly. First, it saves borrowers money by eliminating the costs of refinancing. Additionally, it spares borrowers the time and effort that they currently spend to investigate their refinancing options.

By automating the process by which a borrower obtains a lower rate, the Ratchet Mortgage will in theory optimize the rate paid over the life of the loan compared to the rate paid by borrowers who have to pull the refinancing trigger and risk doing so too early, too late or not at all. And because these rate reductions are not contingent upon a borrower’s current FICO score, the Ratchet Mortgage delivers savings to those that might otherwise be ineligible for but are in great need of refinancing.

Benefits to Lenders
The Ratchet Mortgage has benefits for lenders too. By diminishing the incentive for refinancing-related prepayments, the Ratchet Mortgage would allow a lender to more accurately project future revenue and model the balance sheet. Reduced refinancing activity would lower an institution’s reinvestment risk.

Additionally, lenders would gain the ability to better control their operating expenses, which in the current landscape can be buffeted by refinancing boom-and-bust cycles.

Qualitatively, the Ratchet Mortgage would promote stickier member relationships. Refinance retention rates are a closely guarded secret in the banking world, but are thought to be well below 30 percent. This degree of churn is expensive and wasteful. A stickier relationship, based on the mortgage, presents more cross-selling opportunities. Perhaps most importantly, products like the Ratchet Mortgage create trust that the institution is committed to the borrower’s financial well-being and not exploiting ignorance or passivity.

Ratchet Mortgages in Sync with Credit Union Values
The borrower focus implicit in the Ratchet Mortgage is very much aligned with credit unions’ mission and values. Originators with shareholder obligations might balk at weaning themselves from the higher yields generated by passive borrowers and from the non-interest income that accompanies refinancings. Credit unions, on the other hand, have the flexibility and the capital to offer a better deal to the members.

Furthermore, the cooperative structure of the credit union system would promote adoption of the Ratchet Mortgage. These mortgages are designed to be funded with instruments that similarly ratchet downward, and these could conceivably be facilitated by corporate credit unions.

The Ratchet Mortgage is an intriguing innovation that has the potential to improve efficiency and distinguish credit unions from the mortgage lending crowd.

To learn about another promising mortgage lending opportunity, join us for our upcoming webinar Manufactured Housing – an Affordable Housing Solution, the fourth quarter mortgage lending series webinar brought to you by Callahan & Associates and sponsored by Charlie Mac.

Thank you to everyone who commented on the article. Your comments were very valuable in identifying future topics related to the Ratchet Mortgageä. In the near future, we will either be releasing another article or a webinar on the subject. Until that time, we will be contacting financial establishments to work through the complexities of financing and risk management associated to the Ratchet Mortgage. More to come…

Paul Seizert, Author




Oct. 23, 2006


  • This product would definitely fit in with the credit union culture and values. I would like more information about the product, secondary market investors and lenders currently offering.
    Janet Marcus
  • This product sounds like something our members would come up with but never believe it would happen. In fact I could of used this 2 years ago now that my adjustable rate is coming due within the year. This sounds fantastic!
  • Would definitely like to hear more details on product, current rates, secondary market players for this product, etc. Any info anyone is able to provide would be greatly appreciated.
    Kendall Leverette
  • Need more details...who's currently offering?...who's currently buying on secondary market?
    Barbara Zyla
  • I would be interested in more details on this product and if anyone is currently offering it. It sounds like a niche product that our Credit Union could use.
    Dennis Beadle
  • Where can I learn more about this product? As you noted, it sounds very much in line with the CU ethos, and cutting edge products and solutions like this are what our industry needs to keep differentiating ourselves from the national Mega-banks.
  • Hard to imagine a secondary market for mortgages where the rate can only go down. A good idean in theory may not be a good idea for prudent asset/liability management.
    Terry Coldiron
  • Would like to know more about the author's thoughts on risk rate management and ALCO planning. If one assumes a 30 year balance maturity with a 1 year rate repricing, the ALCO would suggest an offset of one year CD's. But the downside in a rising rate environment is the inability to then match a suitable deposit to this fixed rate asset. Is there a secret ALCO formula to protect the lender?
  • Great, it is like making fixed rate mortgages that can do nothing but down. Our asset/liability management will be non-existant and so will we, because we will be out of business.
  • would like to see an ALM prospective on this product
  • This is a fascinating topic that I hadn't heard of before... My initial reaction is that this seems like a major 'first mover' opportunity - the first few banks/credit unions to roll this out and aggressively market will likely see huge gains in market share and brand perception... There's no question that consumers will love it. But assuming it takes off with those first movers, can credit unions make a business case for entering the market at that point? It would seem that the timing of entry is especially important for credit unions. You're accepting a lower rate in order to hold onto the loans longer... With enough competition in the marketplace, I can imagine a situation in which a CU would have to make the terms so consumer-friendly to compete for new business that they sacrifice too much on the rate side.... Defnitiely something to look into further and think about more - Great job on this, I'd love to see another article on this topic next week.
  • How do you manage the interest rate risk if the loan only reprices downward? Your cost of funds will increase as rates rise but these loans won't. What will that do to margin?
  • Is this product being offered by Credit Unions today? Or, is this just theory at this time? If it is being offered, are CU's holding in portfolio? Has any consideration been given to needing to sell this product into the Secondary Market?
    Tammy Trefny
  • I would definately be interested in learning more details about this niche product. Does it have special Notes/Riders detailing the information being offered? Also, is Fannie or Freddie looking into something like this?
  • I think this product will be widely unaccepted. With interest margins narrowing, refinance related income has helped many credit unions sustain moderate ROA and capital levels. With the evaporation of these refinances and related income, how is it to be replaced? I think it is certainly a good product for the member, but a poor finanical product for a financial institution - have to weigh member service against financial survival.
  • I'd love to be able to offer the rachet mortgage. But we have looked at it and can't find a way to make it work financially. It would be very difficult to manage the interest rate risk with this product. If someone can show me how this would work financially I'd be more interested. It just sounds too good to be true.
    Henry Wirz
  • This is not a new concept, but simply a new name to earlier attempted product versions called The Improving Rate Mortgage (Wells Fargo), the Fixed Rate Convertible (Fannie Mae). Unfortunately, both earlier versions failed. Many causes of failure can be cited, but primary among them were: 1) the idea only works in a high rate environment, 2) investors lose (hence borrowers win) so must "overcharge" and/or charge borrowers upfront for this option, 3) to simply refi is very cheap and competitive in today's market. Additionally, brokers (and some LOs)were steadfast against the concept of a non-recurring transaction model. -These views were obtained during my former tenure as Director, New Product Pricing for a GSE.
    Steve Thomas