Improving the 30-Year Mortgage

Wayne Passmore and Alexander von Hafften have posted Improving the 30-Year Fixed-Rate Mortgage to SSRN. The abstract reads,

The 30-year fixed-rate fully amortizing mortgage (or “traditional fixed-rate mortgage”) was a substantial innovation when first developed during the Great Depression. However, it has three major flaws. First, because homeowner equity accumulates slowly during the first decade, homeowners are essentially renting their homes from lenders. With so little equity accumulation, many lenders require large down payments. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowner might have better uses for this money. Third, refinancing mortgages is often very costly. We propose a new fixed-rate mortgage, called the Fixed-Payment-COFI mortgage (or “Fixed-COFI mortgage”), that resolves these three flaws. This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and no down payment. Also, unlike traditional fixed-rate mortgages, Fixed-COFI mortgages do not bundle mortgage financing with compensation paid to capital markets investors for bearing prepayment risks; instead, this money is directed toward purchasing the home. The Fixed-COFI mortgage exploits the often-present prepayment-risk wedge between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. Committing to a savings program based on the difference between fixed-rate mortgage payments and payments based on COFI plus a margin, the homeowner uses this wedge to accumulate home equity quickly. In addition, the Fixed-COFI mortgage is a highly profitable asset for many mortgage lenders. Fixed-COFI mortgages may help some renters gain access to homeownership. These renters may be, for example, paying rents as high as comparable mortgage payments in high-cost metropolitan areas but do not have enough savings for a down payment. The Fixed-COFI mortgage may help such renters, among others, purchase homes.

The authors acknowledge some drawbacks for Fixed-COFI mortgages that can make them unattractive to some borrowers:

What do homeowners lose by choosing Fixed-COFI mortgages instead of traditional fixed-rate mortgages? First, they cannot freely spend refinancing gains on non-housing items. When mortgage rates fall, homeowners with Fixed-COFI mortgages automatically pay less interest and pay down the mortgage principal more. Second, they can no longer “win the lottery” played with capital markets investors and lock in a substantially lower rate for the remainder of their mortgage. With Fixed-COFI mortgages, homeowners trade the option of prepayment for faster home equity accumulation. We believe that many households may prefer Fixed-COFI mortgages to traditional fixed-rate mortgages. Furthermore, we believe that many renting households without savings for a down payment may prefer Fixed-COFI mortgages to renting. (4)

American households rely too much on the plain vanilla 30-year fixed rate mortgage for their own good. Papers like this give us some reasonable alternatives that might be better suited for many households.

Who Qualifies as a First-Time Homebuyer?

NewHomeSource quoted me in Who Qualifies as a First-Time Homebuyer? It opens,

You don’t always have to be a first-time homebuyer to qualify for down payment assistance programs.

As you consider purchasing a home, you may have come across down payment assistance programs that aim to assist first-time homebuyers.

“How can I qualify?” you might have asked yourself.

It turns out, you don’t always have to be a first-time homebuyer to qualify, even though it might say otherwise in the name.

“Freddie Mac defines ‘first-time homebuyers’ for its Home Possible program as someone who had ‘no ownership interest (sole or joint) in a residential property during the three-year period preceding the date of the purchase of the mortgage premises,’” says David Reiss, professor of law and research director for the Center for Urban Business Entrepreneurship at the Brooklyn Law School.

Freddie Mac, a government-sponsored home loan mortgage corporation, says that its Home Possible mortgages offer low down payments for low- to moderate-income homebuyers or buyers in high-cost or underserved communities.

Another federal mortgage association, Fannie Mae, also offers down payment assistance programs for first-time homebuyers.

“The Fannie Mae standard 97% LTV Options let first-time homebuyers put down 3 percent,” says Reiss. “The program defines a first-time homebuyer as someone who ‘had no ownership interest (sole or joint) in a residential property during the three-year period preceding the date of purchase of the security property.’”

Similarly, the U.S Department of Housing and Urban Development defines a first-time homebuyer as an individual who has had no ownership in a principal residence three years prior to the closing date of the property.

Not a first-time homebuyer under these definitions? There’s hope for you still.

“Given the overwhelming dominance that the FHA, Fannie and Freddie have on the mortgage market, homebuyers who have sat out of the housing market for a while may find that they qualify for first-time homebuyer programs even if they have owned a home before,” adds Reiss.

Additionally, there are also assistance programs available for “displaced homemakers.” A displaced homemaker generally meets the following qualifications:

  • Provided unpaid services to family members in the home, such as a stay-at-home parent,
  • Were given financial assistance from another family member, but are no longer supported by that income and
  • Are unemployed/underemployed with difficulty gaining employment or upgraded pay.

“A displaced homemaker or single parent will also be considered a first-time homebuyer if he or she had no ownership interest in a principal residence (other than a joint ownership interest with a spouse) during the preceding three-year time period,” Reiss says.

Minority Homeownership During the Great Recession

photo by Daniel X. O'Neil

Print by Andy Kane

Carlos Garriga et al. have posted The Homeownership Experience of Minorities During the Great Recession to SSRN. The paper concludes,

The Great Recession wiped out much of the homeownership gains attained during the housing boom. However, the homeownership experience was very different across racial and ethnic groups. Black and Hispanic borrowers experienced substantial repayment difficulties that ultimately led to a greater share of homes in foreclosure.

Given that home equity often represents a substantial share of household wealth, these foreclosure events severely damaged the balance sheets of minority families. The dynamics of delinquency and foreclosure functioned differently across the income distribution within racial and ethnic groups.

For the majority, higher income was associated with lower delinquency rates and fewer foreclosures as a group. However, for Hispanic families this relationship was surprisingly reversed. Hispanics with the highest incomes fared worse than those with the lowest incomes. This counterintuitive finding suggests how college-educated Hispanic families may have had worse wealth outcomes than their non-college-educated peers: Hispanic families with high income (potentially the result of high educational attainment) had a greater share of home equity lost in foreclosure than lower-income Hispanic families.

Logit regressions suggest that underwriting standards and loan structure explain a significant amount of the greater likelihood of foreclosure among Black and Hispanic borrowers. However, underwriting standards explained more of the gap for Black borrowers, while loan structure was a stronger factor among Hispanic borrowers. Regional concentration and variation in housing markets explained more of the Hispanic-White foreclosure gap than any other group. This is understandable given that Hispanic borrowers in our sample were heavily concentrated in housing markets that experienced some of the largest volatility. Despite accounting for these important factors, sizable gaps remain in foreclosures among Blacks and Hispanics relative to Whites. Incorporating measures of labor market outcomes into the analysis may offer further insights.

In sum, the homeownership experience during the Great Recession proved to be inimical for many families, but far more so for Black and Hispanic families. For these families, financially destructive foreclosure events delayed and potentially derailed the dream of homeownership. (164-65)

I am not sure what this all means for housing finance policy other than the obvious: consumer protection in the mortgage market is a good thing as it ensures that underwriting standards evaluate ability-to-repay and loan structures exclude abusive terms like teaser rates (thanks to the ATR and QM rules and the Consumer Financial Protection Bureau). There are probably other policies that we should consider to reduce the depths of our busts, but they do not seem likely to gain traction in the current political environment.

Signs You Are In A Bubble

photo by Jeff Kubina

Trulia.com quoted me in Signs Your Local Real Estate Market Is A Bubble. It reads, in part,

If you were burned in 2008, the last time the housing bubble burst, you’re probably (and understandably!) gun-shy about jumping into the housing market again — especially if you think your local area could be experiencing another bubble. If you buy during a bubble, overpaying for your home, you might be forced to sell for less than the property is worth — either that or stay put longer than you’d like until you build up enough equity to sell. So if you’re thinking of buying, it’s important to have a sense of the signs that point to a real estate bubble. Here are five of them.

1. Shaky loans are common

As we learned from the 2008 recession, subprime lending (lending to anyone with a pulse) is not sound practice. And we have made changes. “Credit remains relatively tight,” says Jonathan Miller, CRE, CRP, and president of Miller Samuel Inc., a New York, NY, real estate appraisal company.

Yet the U.S. government still backs loans that some might consider risky, particularly ones that require only a 3.5% down payment, which the Federal Housing Administration (FHA) offers. Before you get too alarmed, keep in mind that the FHA has been helping people become homeowners since 1934. The underwriting standards are higher with FHA loans than with some of the subprime low-down-payment products offered in the early 2000s, explains David Reiss, professor of law at Brooklyn Law School in Brooklyn, NY.

2. There’s lots of leverage

When you take out a mortgage, you’re leveraging your money — the smaller the down payment you make, the more you have leveraged the deal by using the lender’s money to make the purchase. “A bubble means lots of leverage,” says Miller. “And this [current] cycle has been remarkably devoid of leverage.” Miller cites New York City as an example. “About 45% of the transactions are cash. And for the price points below half a million dollars, the average person puts about 35% down.”

3. Home prices are rising faster than salaries

When housing prices are rising and your salary isn’t, you’re left with two options: continue to rent, or buy a house you can barely afford. If you think your market is in a bubble, you might want to wait to buy, especially if you’re really stretching to make ends meet.

“I would review the mean income levels and employment levels compared to real estate prices for signs of discord,” says Michael Kelczewski, a Pennsylvania and Delaware real estate agent. “Indicators of a local real estate bubble are asset values exceeding the local market’s capacity to absorb prices.” Reiss says that when home prices rise faster than salaries, “It could be the sign of froth in the market.”

Miller agrees that a “rapid run-up in prices that don’t match wage growth leads to discussions about bubbles.” But he says that as long as credit conditions from bank lenders are tight, you won’t have runaway price inflation. In New York, prices aren’t rising like they were, but they aren’t falling either. Miller says they’ve leveled off and are “stuck on a high plateau.”

So what do you do when affordability isn’t improving in pricey markets like New York, NY, San Francisco, CA, Los Angeles, CA, or any other high-cost urban market? Buy in the burbs. Miller notes that for New York, the market is booming in the outlying suburbs.

 *     *     *

When there are no signs

Of course, you might think your market is (or isn’t) in a bubble, but you could be wrong. “The problem with bubbles is that we don’t know them when we see them,” says Reiss. He explains that San Francisco, CA, for example, a hugely unaffordable city for most people, isn’t in a bubble just because prices are high. “Bubbles do not refer to rapid price appreciation. They refer to unsustainable rapid price appreciation. [The market] is unsustainable because fundamentals do not support the appreciation.”

The bottom line is, it’s difficult to know whether it’s really a bubble. “If homeowners buy a house that works for their family and that they can afford over the long haul, they will have made a decision that benefits them every day, even if real estate prices drop significantly,” says Reiss. But heed his warning: “If homeowners instead buy a house that is a financial stretch in the belief that it will appreciate down the road and fund their retirement, there is a good chance that they have set down a road to ruin.”

High and Low Property Taxes

photo by JRPG

Newsmax quoted me in Lowest Property Tax Is Hawaii and the Highest Is New Jersey. It reads, in part,

The average American household spends $2,089 on real estate property taxes each year and residents of the 27 states with vehicle property taxes shell out another $423, according to the National Tax Lien Association.

However, some states cost more than others when it comes to the American Dream and its staples of a house and car.

“Different parts of the country have different levels of taxation and amenities paid for by the tax receipts,” said David Reiss, professor of law and research director with the Center for Urban Business Entrepreneurship at Brooklyn Law School.

The state with the lowest real estate property taxes is Hawaii where residents pay only $482 per household, which is the least average amount typically shelled out by a taxpayer, according to a 2016 WalletHub study, ranking states with the highest and lowest property taxes.

“High property taxes tend to be correlated with high income and high income tends to be correlated with Blue States, so it is not surprising that high property taxes are correlated with Blue States,” Reiss said.

*     *      *

“Local property taxes can help pay for all sorts of municipal services, including schools, road maintenance and emergency services,” Reiss said.

Alabama, Louisiana and Delaware, D.C. and South Carolina follow Hawaii among the states with the lowest property taxes.

High tax localities, such as Westchester County in New York, could have annual taxes that easily are in the tens of thousands of dollars a year range but such areas also have some of the best schools in the nation.

The WalletHub report further found that in Blue states, real estate property taxes are 39% higher at $2,250 a year than homeowners in Red states who pay $1,613.

The yearly burden weighs far more heavily on taxpayers in some states than in others based on region.

For example, communities in the Northeast typically have higher property taxes than many of those in the rest of the country.

“Monthly mortgage payments are usually much higher than monthly real property tax payments, measuring in the high hundreds in low-cost metros like Pittsburgh to the thousands in a high-cost metro like San Francisco so it is hard to put default rates squarely on the shoulders of real property taxes,” said Reiss.

State of Lending for Latinos

Mark Moz/ Commons- Flickr

The Center for Responsible Lending has posted a fact sheet, The State of Lending for Latinos in the U.S. It reads, in part,

At 55 million, Latinos represent the nation’s largest ethnic group and the fastest growing population. However, Latinos continue to face predatory and discriminatory lending practices that strip hard-earned savings. These abusive practices limit the ability of Latino families to build wealth and contribute to the growing racial wealth gap between communities of color and whites. The Center for Responsible Lending (CRL), along with its numerous partners, has sought to eliminate predatory lending products from the marketplace. High-cost, debt trap lending products frequently target Latinos and other communities of color. (1)

No disagreement there. The fact sheet continues,

Barriers to Latino Homeownership

According to a 2015 national survey of Latino real estate agents, nearly 60 percent said that tighter mortgage credit was the No. 1 barrier to Latino homeownership; affordability ranked second.

In 2014, Latino homeownership dropped from 46.1 percent in 2013 to 45.4 percent. In 2013, Latinos were turned down for home loans at twice the rate of non-Latino White borrowers and were more than twice as likely to pay a higher price for their loans. (1)

I have a few problems with this. First, I am not sure that I would unthinkingly accept the views of real estate agents as to what ails the housing market. Real estate agents make their money by selling houses. They are less concerned with whether the sale makes sense for the buyer long-term. Second, it is unclear what the right homeownership rate is. Many people argue that higher is always better, but that kind of thinking got us into trouble in the early 2000s. Finally, stating that Latinos are rejected more frequently and pay more for their mortgages without explaining the extent to which non-discriminatory factors might be at play is just sloppy.

The fact sheet quotes CRL Executive Vice President Nikitra Bailey, “As the slow housing recovery demonstrates, there is a market imperative to ensure that Latino families have access to mortgages in both the public and private sectors of the market. The market cannot fully recover without them.” (1) But what Latino households and the housing market need is not just more credit. They need sustainable credit, mortgages that are affordable as homeowners face the expected challenges of life — unemployment, sickness, divorce. It is a shame that the CRL –usually such a thoughtful organization — did not address the bigger issues at stake.