Some ideas for reforming the mortgage and housing markets are better than others. Recommending borrowers stop using fixed-rate mortgages at the bottom of the interest-rate cycle is a very foolish recommendation.
Irvine Home Address … 28 COLDBROOK Irvine, CA 92604
Resale Home Price …… $1,199,000
Cocaine decisions…
You are a doctor or a lawyer
You got an office with a foyer
And the cocaine decisions that you make today
Will not be discovered till it's over 'n' done
By the customers you hold at bay
Frank Zappa — Cocaine Decisions
The decisions we make today concerning the mortgage and housing markets will have long-lasting ramifications. So far, the policies lenders have been following in cahoots with our government are fostering moral hazard. Now some bureaucrats are trying to undermine the very foundation of prudent borrowing: the 30-year fixed-rate mortgage.
Radical Ideas From a Federal Housing Bureaucrat
By James R. Hagerty
As the chief economist of the Federal Housing Finance Agency, Patrick Lawler … launched a frontal assault on the most sacred element in U.S. housing-policy dogma: the 30-year fixed-rate mortgage loan, providing the right to refinance at any time, with no prepayment penalty. If more members of the audience had been fully awake at this moment, I feel sure that their gasps would have been audible.
The reason people at this event might have gasped is because the 30-year fixed-rate mortgage is a good idea, particularly now at the bottom of the interest rate cycle. The author of this article, James R. Hagerty, obviously disagrees. He is a fool.
Now, Americans are very attached to their 30-year fixed-rate freely prepayable mortgages. They like not having to fuss about the possibility of 28% interest rates in 2032, even though most of us will move or die long before then. They love to refinance every time rates drop and then brag to their neighbors about how much they are saving per month.
Notice the emotional derisiveness in the comments about bragging to the neighbors and the ridiculous overstatement about 28% interest rates after we die. People who managed their risk well by utilizing 30-year fixed-rate mortgages should brag to their neighbors. They were smarter than their neighbors who used adjustable-rate mortgages and assumed interest rate risk. People who use fixed-rate financing can still take advantage of lower interest rates by refinancing, and they lock in protection against higher rates. This is smart.
What they don’t stop to realize often enough is that they are paying a very large price for that privilege– twice.
This is an exaggeration. People do pay a premium for fixed-rate financing, but it isn't a "very large price" as this author erroneously contends.
In the first place, mortgage rates are higher than they otherwise would be. That’s because lenders and mortgage investors must build in protection for the risk that we will prepay and stick them with a lower yield than they were anticipating. Mr. Lawler estimates that Americans pay at least an extra 0.25 to 0.50 percentage point in rates because of this option to prepay without penalty. They also pay another premium-–sometimes a percentage point or two–for having a long-term fixed rate. Over 30 years, that translates into some real money, but no one ever mentions that when bragging to the neighbor.
Notice he slips in another comment about bragging to the neighbors. I suspect this guy has an adjustable-rate mortgage. When interest rates go up and his payments along with them, I wonder if he will feel so smug about his choices. Also, the premiums he stated are a ridiculous exaggeration. Nobody is paying one or two percent more for fixed-rate financing.
In the second place, our nation has created the likes of Fannie, Freddie and the FHA to facilitate these oddball 30-year fixed-rate loans, which aren’t normally provided by the private market.
That statement crosses the line between exaggeration and outright lie. Thirty-year fixed-rate mortgages are not "oddballs" that would not exist if not for the GSEs and the FHA. It may look that way today because there is no market other than what these entities provide, but that is because there is no private market of any kind for mortgages at today's interest rates. If it isn't government insured, it isn't underwritten. These oddball loans have been around for decades, and they are the stable base of a housing market.
For a long while, that seemed like a free lunch. Fannie and Freddie, we were told, were far better able to handle those complex risks than we dumb consumers ever could. But since the government had to rescue Fannie and Freddie in 2008, the taxpayers’ tab for this indigestible lunch has swollen to $145 billion, and it’s still rising. So that’s the second time we’ll pay for our irrational love of American-style mortgages – only this time, we all pay, not just mortgage borrowers.
This guy is saying that the problems with the GSEs are caused by 30-year fixed-rate mortgages. That is a lie, pure and simple. The GSEs got in trouble because they insured and purchased toxic mortgages. It isn't their 30-year fixed-rate mortgages that are causing massive losses. This writer is using lies and emotional exaggerations to support his contention that these loans are bad. It is irresponsible journalism, and he should be ashamed.
Meanwhile, other wealthy nations–notably Canada–do without our kind of mortgages and yet somehow manage to have homeownership rates similar to ours. They do not pretend that there are risk-free ways to buy houses on credit.
Canadians also do not have a mortgage interest deduction, so people are strongly encouraged to pay off debt rather than endlessly add to it and service it. Also, the wise Canadians recently inflated their own housing bubble as people foolishly used low-interest mortgages to bid up prices. The author forgot to mention that.
Mr. Lawler then skewered one of the favorite arguments of those who assert that we need Fannie and Freddie–their ability to borrow money all over the world, drawing in foreigners’ savings to finance ever-larger McMansions (which then need to be filled with Asian gadgets and European gewgaws). But why exactly do we need all of that foreign investment in our mortgages? Mr. Lawler asked: “A good case can be made that we massively over-invest in housing.” Indeed, we might be better off investing any money foreigners lend us in something that would help us sell more of our goods and services to those foreigners so we can hope to pay them back one day.
All too soon, Mr. Lawler’s time was up, but he blurted one last revolutionary chant before resuming his role as a bland bureaucrat: “We can do with a lot less government involvement and still get what we want, just by making some fundamental changes.”
What fundamental changes would those be? The author obviously thinks one of these fundamental changes should be eliminating the 30-year fixed rate mortgage. I think he is a fool.
Loans for the purchase or refinance of residential real estate secured by a mortgage and recorded in the public record are limited by the following parameters based on the borrower’s documented income and general indebtedness and the appraised value of the property at the time of sale or refinance:
1. All payments must be calculated based on a 30-year fixed-rate conventionally-amortizing mortgage regardless of the loan program used. Negative amortization is not permitted.
2. The total debt-to-income ratio for the mortgage loan payment, taxes and insurance cannot exceed 28% of a borrower’s gross income.
3. The total debt-to-income of all debt obligations cannot exceed 36% of a borrower’s gross income.
4. The combined-loan-to-value of mortgage indebtedness cannot exceed 90% of the appraised value of the property or the purchase price, whichever value is smaller except in specially sanctioned government programs.
Any sums loaned in excess of these parameters do not need to be repaid by the borrower and no contractual provision is permitted that can be interpreted as limiting the borrower’s right to exercise this right, make the loan callable or otherwise abridge the mortgage agreement.
That is the kind of fundamental change we would live with.
Scheduled for auction 28 years after purchase 
Family homes have historically been a great retirement savings vehicle because people were forced to save through the amortization on their loan. California owners in particular have had opportunity to fund their retirements from an influx of high wage earning buyers driving up home prices. Unfortunately, with the Great Housing Bubble, many owners extracted their retirement savings and spent it.
- Today's featured property was purchased on 7/12/1982 for about $400,000 based on the property tax records. The owners original financing is unknown, but it was likely an 80% loan with a 20% down payment.
- On 12/11/2001 they obtained a $600,000 first mortgage.
- On 2/4/2003 they refinanced with a $605,000 first mortgage.
- On 5/3/2004 they opened a $100,000 HELOC.
- On 3/28/2005 they refinanced with a $743,000 first mortgage.
- Here is where it gets strange; on 4/3/2007 the refinanced with a $600,000 first mortgage which required them to pay down the first by $143,000.
- Total property debt is $600,000.
- Total mortgage equity withdrawal is about $200,000.
According to Foreclosure Radar, these owners defaulted in April, and they are scheduled for auction in August. Since they have about $600,000 in equity, it is safe to assume they will sell prior to their auction or get a loan modification. It may be this is an unemployment problem. For whatever the reason, these owners are being compelled to sell a house they have been living in for almost 30 years under threat of foreclosure.
Twenty-eight years after purchase, and their mortgage has doubled, and they are about to lose their homes. Very foolish, and very sad.
Irvine Home Address … 28 COLDBROOK Irvine, CA 92604 
Resale Home Price … $1,199,000
Home Purchase Price … $400,000
Home Purchase Date …. 7/12/1982
Net Gain (Loss) ………. $727,060
Percent Change ………. 181.8%
Annual Appreciation … 4.0%
Cost of Ownership
————————————————-
$1,199,000 ………. Asking Price
$239,800 ………. 20% Down Conventional
4.80% …………… Mortgage Interest Rate
$959,200 ………. 30-Year Mortgage
$242,643 ………. Income Requirement
$5,033 ………. Monthly Mortgage Payment
$1039 ………. Property Tax
$0 ………. Special Taxes and Levies (Mello Roos)
$100 ………. Homeowners Insurance
$73 ………. Homeowners Association Fees
============================================
$6,245 ………. Monthly Cash Outlays
-$1365 ………. Tax Savings (% of Interest and Property Tax)
-$1196 ………. Equity Hidden in Payment
$440 ………. Lost Income to Down Payment (net of taxes)
$150 ………. Maintenance and Replacement Reserves
============================================
$4,273 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$11,990 ………. Furnishing and Move In @1%
$11,990 ………. Closing Costs @1%
$9,592 ………… Interest Points @1% of Loan
$239,800 ………. Down Payment
============================================
$273,372 ………. Total Cash Costs
$65,500 ………… Emergency Cash Reserves
============================================
$338,872 ………. Total Savings Needed
Property Details for 28 COLDBROOK Irvine, CA 92604
——————————————————————————
Beds: 4
Baths: 3 full 1 part baths
Home size: 3,600 sq ft
($333 / sq ft)
Lot Size: 5,665 sq ft
Year Built: 1980
Days on Market: 60
Listing Updated: 40343
MLS Number: S613788
Property Type: Single Family, Residential
Community: Woodbridge
Tract: Gb
——————————————————————————
According to the listing agent, this listing may be a pre-foreclosure or short sale.
Classic home never goes out of style. Good taste, superb craftmanship, prime location combine to create this sought after home in Woodbridge. This beautifully constructed and appointment home is a haven for comfort and family. This home is beautifully remodeled throughout. A generous family room warmed by the brick fireplace, is a place where everyone can relax. Gourmet kitchen features stainless steel appliances, double oven, warmer and walk-in pantry. Den includes a bar with wine room, perfect for entertaining. Bonus room with built-in cabinets, ceiling fan and a balcony. Master Bedroom with plenty of closet space and a private deck with views of peaceful trees, tennis courts and a peek-a-boo view of Woodbrige North Lake, leads to the backyard with a spiral staircase. Enjoy the outdoors with a private pool, spa, fireplace and a built-in BBQ. Enjoy Woodbridge ammenities: two lakes, pools, tennis courts, parks and Lagoon.
There is no way that this house was anywhere near 400k in 1982.
I’d bet that it was closer to $200k judging by the taxes.
I have to agree. In 1983 I passed up a new single level 3/2 in East Lake Village for approx $130K. Granted, Yorba Linda v. Irvine, but I can’t remember seeing $400K tract homes anywhere back then.
You’d lose that bet.
$400K in ’82 sounds right on the money.
It might have sold for $200K in ’85. By ’87 the largest new homes in Westpark (2200 sq feet)were selling for $215K.
And this large home is _very_ close to the lake.
Ooops… I got the decade wrong.
400K might indeed be on the high side on 82, NOT 92.
But, this is a large home just steps from the lake. It is an unusually large home from Irvine -discounting the McMansions from the 00s.
This is a short sale!
I think the purchase price in 1982 would have been in the 5-digits but space addition and improvements to the property raised property tax on it to the current ~ $435,000. Redfin shows it as 2,595 sq.ft. so they may have added a 1,000 sq.ft. or so. Also, Redfin shows it as a short sale which makes me think that the $600,000 loan was a second mortgage not a refinance which makes total property debt about $1,343,000 – hence the short sale. JMHO.
Correction: I meant to say that the current assessed value is $435,000 (tax would be 1% or so) of that.
Lawler does does have a partial point that there is a premium built in for the prepayment option and the 25-50 bp range is consistent with what I have heard in the past.
I know in some markets, like Australia, fixed rate loans have prepayment penalties though loans are portable subject to appraisal so a sale in and of itself doesn’t trigger a prepayment. I recall a while back there were products that offerred a lower rate in exchange for some prepayment penalty if the loan was refinanced but they never really took off. It may have been in a higher rate environment (where a refi over the life of the loan was more likely) and the discount was insufficient.
This looks like a pretty decent home and from the pictures it does appear to be very well maintained – the HELOC money was probably put in the house. I noticed this week’s featured houses are in $1m+ range and it seems the bigger problem is the big jump in financing costs once you need to finance more than $729k. Assuming someone is putting down 20% this means it is effectively very difficult to bid much over $900k ie once you need to borrow anything incremental over FNMA limits the economics erode pretty quickly.
IrvineInvestor: “… the 30-year fixed-rate mortgage is a good idea …”
There is better idea: take 10-year ARM, but pay it as 15-year FRM.
This is exactly what I am going to do when I buy my next house, provided that there is no penalty for paying off early
Maybe they have medical issues or need to go to an expensive retirement home? If they purchased 28 years ago, it is quite possible the owners are rather old now. Another oddity-the listing square footage is about 1,000 sq ft more than what is on the tax rolls.
IR – I truly admire you for putting up with the nonsense.
What’s wrong with 5 or 10 year mortgages and 50% down payments?
What is so magical about a 30 year mortgage and a 20% down payment?
It doesn’t make a whole lot of sense to me that people on average buy a house with a 30 year loan and sell within 7 years. No wonder the banks collect all the interest up front in this initial timespan – keeps the slaves in perpetual debt.
If this is the case and we want to encourage people to build equity then it would seem that we need to scale down the timeline.
David,
You can’t create a debt slave generation with 50% down payments.
Besides, that’s like stuffing your cash under your mattress, or so David Lereah told me.
Chuck
What’s wrong with 5 or 10 year mortgages and 50% down payments?
How do you propose implementing this without destroying the current structure? So we go back to only 25% of the population being able to “own” real estate?
Theoretically, it would be nice but realistically what you propose is close to impossible.
“How do you propose implementing this without destroying the current structure? So we go back to only 25% of the population being able to “own” real estate? Theoretically, it would be nice but realistically what you propose is close to impossible.”
No its not. The free market free of government intervention would ensure people could only purchase that which they could afford. So, home prices would come down to meet the demand.
Presently, the market consists of the government loaning money to keep home prices high. When the loan owners default, the taxpayers pay for it.
The free market free of government intervention is the subprime mortgage crisis.
You could not possibly be more wrong. A subprime market would very likely exist in a free market, but there would be very little default. This was never a subprime problem. It was and still is a debt problem brought on by government/federal reaserve manipulated interest rates and fractional reserve banking. Government intervention instigated 95% of the present exageration in the business cycle. And public ignorance of the the government’s role is responsible for the other 5%.
Aww gee….I agree.
It’s a good compromise, especially in the old days when people tended to work at one job and stayed put. (Very few people could afford the terms you propose.) That is, a typical age to buy a house would be 35, so at 65 when they retire and their income drops somewhat, they would no longer have a house payment. More people bounce around from company to company (and from one part of the country to another part), so such are somewhat obsolete. However, IMHO, if your job is that type (semi-temporary), you shouldn’t ever buy a house (you should rent).
Well said. The 30 yr mortgadge is a big contributor to the high inflation in housing. I also hate how people have been fooled into believing equity is profit. Equity has a zero rate of return. It is not appreciation.
50% downpayments are standard in some places, such as Israel (according to my MIL, who is an Israeli economist). Most people there still buy homes; they just buy much smaller homes than we do here. There’s also a culture that once you own the home free and clear, you don’t immediately take out another mortgage and buy something bigger; instead, you start saving for the downpayments on your children’s homes, which you’ll be expected to help with.
A lot of Americans would not be satisfied with the size of an average Israeli middle-class apartment, but the lower family indebtedness does prevent a lot of other problems.
The issue is that people have near zero ability to follow through on financial commitments. If you set up an ARM and pay it like a 15, I’d guess the majority of people within a year revert to the lower payment. Then they call me to refinance into a 30.
Requiring home buyer education before 1st timers get a loan, at least 5% down, and debt to income ratios no higher than 36% Gross Income would help stem the default rate and push prices back down to affordable levels. I’m not selling a house now, and when people say they want prices to be lower, a seller doesn’t want to be forced into that position, but the kind of appreciation we’ve experinced is unnatural and some cure must be applied no matter how difficult tasting the medicine might be.
My .02c
Soylent Green Is People.
I have to agree with the author that a 30 year FRM is a bad idea, but for a different reason–it’s just too long. If you buy your first home at 30 years old (a very reasonable time for a responsible person to buy a first home), then you are paid off at 60 years old at best. If you sell after the typical 7 years, the only way you have equity is through appreciate–if you are so lucky.
A 15 year FRM is a much more reasonable product that allows one to obtain equity in a flat market. Best of all, you can pay off by 45 and live “rent free.”
I agree. If you can afford the payment on a 15-year FRM, it is a better form of financing. Unfortunately, with prices elevated to their extremes, taking on a 15-year mortgage means accepting a much smaller and less desirable property.
It depends on your job situation and future plans. If you are in a type of job where you will basically be at one job until you retire, a thirty year mortgage makes sense. If not, you probably shouldn’t buy at all-you should rent. Of course, then you get to continue to make rental payments after you retire.
Plus, the compromise seems to work here. Since there usually isn’t a prepayment penalty in the US (as discussed in the article), take advantage of that fact. Take out a 30-year mortgaga, and make extra payments if you can.
High home prices help the banks in the form of interest paid. The banking cartel has more power and control over society than I could have imagined.
Welcome to the Moneytrix. Wish you took the blue pill?
“Stocks slide after new home sales drop 33 percent
Stocks drop after new home sales fall to record low in May; End of tax credits hurts demand” Yahoo API story.
Less than one month ago it was reported as record sales and price increases. Another pump and dump.
Let’s have another round of pump and dump at taxpayers’ and renters’ subsidized expense before the elections.
I disagree that a 30 year loan is a bad. In inflationary times, you will be paying back with inflated currency; if deflation, just pay off the loan early.
All the exotic financing of recent years makes the 30yr fixed loan seem like a really prudent and best-of-breed loan. But it is only because everything is relative.
Before all the exotic financing I used to think the 30yr fixed loan, was the worst “prudent” loan. That is, it was borderline with being prudent. The fixed rate part is prudent, but 30yrs length is practically a lifetime. If you buy your home when you are 30, you pay it at 60, just when you are getting ready to retire. This is “fine” but it is so close to renting, it is not funny. I always thought the 30yr fixed mortgage is the maximum banks could get away, squeezing the american population as much as it was possible. Yet they were able to “invent” other stuff that went beyond prudence.
10%-20% downpayment is also the least amount a “prudent” lender should accept, and the minimum a “prudent” borrower should put down.
Now, to be really smart and responsible, you shouldn’t go beyond 15-20 years, and I would certainly advise fixed rate at this point in time, and a 25% down (and 6 months of savings). Who could afford a home with these parameters? yeah, almost nobody right now, but eventually things would adjust.
Ha! Don’t count on it. Our govt and bank would go back to a fuedalistic system before they would let this happen.
75 million dollar “as is” mansion
http://www.azcentral.com/business/realestate/articles/2010/06/22/20100622florida-unfinished-mansion.html
Since were going back to fuedalism, instead of Mr. it will be serf or peasant for the common folk.
I know 😉 I could only hope people would be smart enough to tell the government and banks “screw you” I’m only going to do what is prudent and best for me 🙂 but that is just as hard.
With the govt bailout and sticking it to the taxpayers, the debt has been billed to you and your children and their children. Even with prudence and without your approval, the bill will be due.
Sheesh… isn’t the bottom of the interest-rate cycle the best time lock in a good 30 or 15 year fixed rate? Why do politicians and policy-makers fail to understand the most elementary of concepts, and worse, promote and reward bad behavior?
IRS Audits Block 10% of First-Time Homebuyer Credits (Update1)
http://noir.bloomberg.com/apps/news?pid=20603037&sid=aH94v_v0j_x4
i’m sure the government missed a few cheaters and that number is higher.
anywhere there’s a lot of money transacted people will commit fraud.
the government isn’t smart enough to catch all the cheaters; i’m happy they at least caught some of them.