“The key was to make it a 15-year loan, which allows borrowers to pay off the principal – and build equity – much faster and generally at a lower interest rate because shorter-term loans are less risky for lenders. Still, a shorter term also means higher monthly payments…

…The Wealth Building loan requires borrowers to have private mortgage insurance and restricts them from taking out a home equity loan. To enable borrowers to afford to pay “points”—an upfront fee that lowers the interest rate—the mortgage program allows loans to cover up to 100 percent of the value of the home, as opposed to the 96.5 percent cap in Federal Housing Administration mortgages.”, Karen Weise, “A Better Mortgage for Lower-Income Borrowers”, Businessweek

“Count me as a skeptic. I don’t think this new loan is going to be more than a small niche product; maybe for young, higher income borrowers who don’t have a down payment saved yet? Today, a 30-year fixed rate mortgage is about 4.25% and 15-year fixed rate mortgage is about 3.375%. If you assume a $200,000 mortgage, then the P&I payment would be $984 a month for the 30-year and $1,418 a month for the 15-year. That’s a 44% monthly payment increase, for this new loan, for a “low income” individual or family!!! (And I know the article says they are somehow going to get better 15-year rates, but how? The market is the market, plus these loans require costly private mortgage insurance that adds to the borrowers monthly payments.) Realistically, how big is the market for lower income homebuyers to enter into much higher monthly mortgage payments? I think it will be small. It’s kind of a forced savings plan for borrowers who put no equity down. A borrower could economically accomplish similar results, with a lot more payment flexibility (they might have an income diminution or disruption in income some day and need a lower payment), by taking out a 30-year mortgage and when they had excess funds, voluntarily pay down their mortgage. But they don’t trust the borrower to act responsibly. So they want to force them, contractually in the mortgage, to build equity through mandatory principal pay-downs and restricting them from tapping any future home equity.  For a long time, the U.S. model has been that the Fed, our central bank, creates 2% nominal annual inflation over the long run. This creates the same or more in annual nominal home price appreciation over the long run. I have argued (a lot) on this blog that I am not a fan of the Fed and its manipulation of money and rates, but the current reality is that the Fed-engineers nominal inflation in home prices.  And we know, from just the simple analysis above, that more lower income Americans can afford a home, with a 30-year mortgage, than can afford one with a 15-year mortgage. Probably millions more.  That’s the monetary policy/housing finance model (like it or not) that we have built in the U.S. for lower income Americans to be able to afford a home and start building wealth. And while I am against the Fed’s free market distortions, we have to deal with this reality and acknowledge that this monetary policy/housing finance model worked pretty well, except during an unprecedented housing bubble and bust.  I think we would be well-served to be realistic about what kind of payment lower-income Americans can really afford and instead focus our policy efforts on preventing massive, unsustainable housing, and other asset, bubbles. That being said, if the Fed stopped its monetary distortions, including engineering monetary inflation (which many economic experts argue are one of the primary causes of our housing and other asset bubbles) then this new mortgage would have more merit. But even then, let’s not fool ourselves, this new mortgage is a niche product.  If it replaced the government’s 30-year fixed rate, low or no down payment mortgages for lower income Americans (as Mr. Pinto wants), likely millions of lower income Americans would not be able to afford the monthly mortgage payment to buy a home.”, Mike Perry, former Chairman and CEO, IndyMac Bank

A Better Mortgage for Lower-Income Borrowers

By Karen Weise September 15, 2014

The economic recovery has lifted values for many homeowners, but stagnant wages and tighter lending standards have locked many low- and moderate-income families out of the market. A pair of unlikely partners think it has a solution. On one side is Edward Pinto, a scholar at the conservative think tank American Enterprise Institute who has blamed the financial crisis on government affordable-housing policies. On the other is Bruce Marks, a longtime consumer advocate who founded and runs the Neighborhood Assistance Corporation of America. They’ve just launched a new program, which NACA is testing for Bank of America (BAC), to try to create a mortgage that’s both more affordable and less risky for borrowers and lenders.

Pinto says he and Marks started working on the idea after clashing on a panel in May. Pinto was skeptical of the typical way to help lower-income borrowers—reducing the amount of down payment on a 30-year mortgage. He says the housing crash showed that people who aren’t well-off can’t build equity fast enough in a typical 30-year loan, which makes them more vulnerable if the economy and home prices slump. “The volatility around one house in any given locality can be huge,” Pinto says. “We have put the people who can least afford the volatility into a house.” Marks’s nonprofit, on the other hand, is dedicated to helping low- and moderate-income people buy homes, often by helping them get loans with no down payment.

They agreed to meet and engaged in what Pinto calls “a very loooong, detailed conversation” about how to help people afford homes while they build equity faster. After the initial session, Pinto says, they “spent hours and hours and hours meeting and talking and outlining how this can done.” Eventually, they came up with a mortgage they call the Wealth Building Home Loan.

The key was to make it a 15-year loan, which allows borrowers to pay off the principal—and build equity—much faster and generally at a lower interest rate because shorter-term loans are less risky for lenders. Still, a shorter term also means higher monthly payments. To counter this, they looked for way to reduce the interest rate. The Wealth Building loan requires borrowers to have private mortgage insurance and restricts them from taking out a home equity loan. To enable borrowers to afford to pay “points”—an upfront fee that lowers the interest rate—the mortgage program allows loans to cover up to 100 percent of the value of the home, as opposed to the 96.5 percent cap in Federal Housing Administration mortgages. Pinto says he hopes some banks will cover the cost of points for some low-income borrowers as part of their community development programs.

In assessing creditworthiness, lenders typically focus on monthly payments as a percentage of borrowers’ income. Pinto’s program uses the so-called “residual income” approach that the Veterans Administration successfully uses. As I reported this summer, many economists prefer the VA’s approach, which adds up what a family spends on necessities such as transportation and child care and then looks at what’s left for housing. This approach to underwriting should make the loans less risky—which should, in turn, lower the interest rate.

Pinto says he’s in discussions with regional banks and mortgage lenders to start additional pilot programs. “In order to be a game-changer, you need to have a lot of people doing it,” Pinto says, pleased with the response he and Marks found when they announced the program at a recent conference. There, Joseph Smith, monitor of the $25 billion National Mortgage Settlement over faulty foreclosure practices, said in prepared remarks that after doing “a lot of listening” to borrowers, advocates, and public officials, he’s come to believe that “absent substantial home equity at the outset, the 30-year fixed rate mortgage increases the fragility of a borrower’s overall financial position and puts the borrower at risk for a very long time.” Smith praised the new program, adding: “Gentlemen, I tip my hat to you.”

 

Weise is a reporter for Bloomberg Businessweek in New York.

Posted on September 16, 2014, in Postings. Bookmark the permalink. Leave a comment.

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