Tag Archives: mortgage

Low Down Payment or Low Interest Rate?

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MainStreet.com quoted me in Consumers Should Not Assume a Lower Down Payment Is a Better Option. It reads, in part

First-time homeowners are often caught in a conundrum when they are faced with tantalizing offers of either lower mortgage rates or a smaller down payment.

The decision is much harder to make than it appears because of many variables such as the stability of your profession, the likelihood of buying another home within a few years and the long-term costs of higher payments.

While at first glance paying a smaller down payment sounds like the obvious choice for many Millennials and Gen X-ers who want to own a home, but are also saddled with student loans and credit card debt, the decision has other ramifications. A higher mortgage rate means paying thousands of extra dollars in interest alone over time.

A recent study conducted by the Federal Reserve Bank of New York found that when a lower down payment is required, it affects the demand on housing more as additional consumers are eager or able financially to purchase a house. Changes in the mortgage rate have a “modest” effect, wrote Andreas Fuster and Basit Zafar, both senior economists at the Federal Reserve Bank of New York’s research and statistics group. The study asked 1,000 households what would affect their willingness to buy a home if they were to move to a similar city and a comparable home.

When the households were offered either a 20% down payment compared to a 5% down payment, the number of people willing to pay for a house rose by 15% when the lower amount was an option.

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Advantages of Lower Interest Rates

While a lower down payment might be more appealing for a first time homebuyer, it can often result in paying more money just on the interest alone, said David Reiss, a law professor at Brooklyn Law School in N.Y. Lenders offer mortgage rates largely based on the credit score of the homeowner, so a cheaper interest rate may not always be available.

Let’s say the homebuyer is considering a $100,000 property that is paid for with a $90,000 interest-only mortgage with a 4% interest rate and a $10,000 down payment or with a $95,000 interest-only mortgage with a 5% interest rate and a $5,000 down payment.

The first mortgage means the consumer would pay $3,600 a year in interest. However, the second mortgage results in the consumer paying $4,750 a year in interest.

“That is not an apples-to-apples comparison, because the second mortgage interest payment reflects the higher loan to value ratio and the higher interest rate and it also does not take into account the tax treatment of interest payments,” he said.

Homeowners need to decide if paying additional money in interest is “worth it,” since a consumer would pay about $1,000 a year more in interest for the “privilege of paying the lower down payment,” Reiss said.

“I think that it is smart to figure out how to pay as low of an interest rate as possible, given the other financial constraints you face,” he said.

Many consumers believe there is not much of a difference between a 3.5% or 4% mortgage rate, but it can result in another few hundred dollars each month in mortgage payments, which can add up easily in 30 years.

Refinancing a mortgage in the current market conditions means your rate is not likely to decline much, so receiving a lower rate now will have a larger impact over the next 30 years, he said. After paying closing costs, many homeowners do not see the impact of the lower rates until the fourth year after the refinancing occurred.

“Since refinancing requires a large upfront cost of thousands of dollars, you need to live there long enough for it to make sense if you are only saving less than 1% on your mortgage rate,” he said.

Seniors Selling Their Homes

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AARP Magazine quoted me in Selling Your Home. It reads, in part,

Judy and Joe Powell recently faced a decision most of us will eventually have to make: Should we sell our home and downsize to save money and effort, or hang on to the homestead because it’s familiar and full of fond memories?

After mulling the choice for a couple of years, the Texas couple decided to sell their 20-acre cattle ranch to move to a nearby college town.

“We are the sole caretakers of this property. It’s 24/7,” says Judy, 69, who mows the pastures with a John Deere tractor while her husband, 71, tends the cattle. “Basically, we don’t want to have to work this hard. We want time to play.”

The Powells now have their sights set on a single-story house in nearby College Station, where, for a monthly fee, someone else will maintain the yard. What’s more, they will be 30 minutes to an hour closer to their friends and doctors. The savings on gas alone will be more than a thousand dollars a year, Judy says.

Most of us aren’t dealing with the rigors of running a ranch. But, like the Powells, many of us will discover at some point that our homes, though we love them, no longer suit our lifestyles, or that they are becoming labor-intensive money pits.

A recent Merrill Lynch survey of people’s home choices in retirement found that a little more than half downsized and, like the Powells, were motivated by the reduction in monthly living costs and by shedding the burden of maintaining a larger home and property. Still, moving is not a decision easily made.

“The tie to one’s home is the hardest thing to understand from the outside. It’s a very personal decision,” says Rodney Harrell, a housing expert with the AARP Public Policy Institute.

Some people may be reluctant to move from a house where they raised children and created decades of memories, he says. On the other hand, the cul-de-sac that provided a safe place for kids may be isolating if driving becomes a challenge.

A good way to begin the process of figuring out what’s best for you is to “recognize the trade-offs,” Harrell says. First, consider the house itself. Is it suitable for your needs, and will it allow you to age in place? Most homes can be easily modified to address safety and access issues, but location is also critical.

“How close are health facilities?” asks Geoff Sanzenbacher, a research economist with the Center for Retirement Research at Boston College. “Are things nearby, or do you have to drive?”

Even if your current home meets these age-friendly criteria, you need to consider whether it is eating up money that could be spent in better ways to meet your changing needs.

For example, the financial cushion provided by not having a mortgage can be quickly erased by rising utility costs, property taxes and homeowner’s insurance. There is also the looming uncertainty of major repairs, which can cost thousands of dollars, such as a new roof and gutters, furnace or central air conditioner. A useful budgeting guide is to avoid spending more than 30 percent of your gross income on housing costs, says David Reiss, a professor at Brooklyn Law School who specializes in real estate finance.

“This isn’t a hard-and-fast rule, but it does give a sense of how much money you need for other necessities of life, such as food, clothing and medical care, as well as for the aspects of life that give it pleasure and meaning — entertainment, travel and hobbies,” Reiss says.

So if your housing expenses are higher than a third of your income or you’re pouring your retirement income into your house with little money left to enjoy life, consider selling and moving to a smaller, less costly place.

Just as important, once you’ve made the decision, don’t dawdle, Sanzenbacher says. The quicker you move, the faster you can invest the proceeds of the sale and start saving money on maintenance, insurance and taxes.

Take this example from BC’s Center for Retirement Research: A homeowner sells her $250,000 house and buys a smaller one for $150,000. Annual expenses, such as utilities, taxes and insurance, typically amount to 3.25 percent of a home’s value, so the move to the smaller home saves $3,250 a year right off the bat.

Moving and other associated costs would eat up an estimated $25,000 of profit from the sale, leaving $75,000 to be invested and tapped for income each year.

If all of this sounds good, your next decision is where to move. Your new location depends on any number of personal factors: climate; proximity to family and friends; preference for an urban, suburban or rural setting; tax rates; and access to medical care, among other considerations.

“You want to take an inventory of your desires and start to think, ‘Do I have the resources to make that happen?’ ” Reiss says.

Wednesday’s Academic Roundup

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Friday’s Government Reports Roundup

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MERS Victorious

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Montgomery County, PA Courthouse

The U.S. Court of Appeals for the Third Circuit ruled in favor of MERS in Montgomery County v. MERSCORP, (August 3, 2015, No. 15-1219) (Barry, J.). MERS, for the uninitiated,

is a national electronic loan registry system that permits its members to freely transfer, among themselves, the promissory notes associated with mortgages, while MERS remains the mortgagee of record in public land records as “nominee” for the note holder and its successors and assigns. MERS facilitates the secondary market for mortgages by permitting its members to transfer the beneficial interest associated with a mortgage—that is, the right to repayment pursuant to the terms of the promissory note—to one another, recording such transfers in the MERS database to notify one another and establish priority, instead of recording such transfers as mortgage assignments in local land recording offices. It was created, in part, to reduce costs associated with the transfer of notes secured by mortgages by permitting note holders to avoid recording fees. (4, footnote omitted)

I, along with others, had filed an amicus brief in this case. The court states that

We acknowledge the arguments of the Recorder and her amici contending that MERS has a harmful impact on homeowners, title professionals, local land records, and various public programs supported in part by the fees collected by Pennsylvania’s recorders of deeds. In this appeal, however, we are not called upon to evaluate how MERS impacts various constituencies or to adjudicate whether MERS is good or bad. Just as the Seventh Circuit observed in Union County, while the Recorder is critical of MERS in several respects, “[her] appeal claims only that MERSCORP is violating [state law] by failing to record its transfer of mortgage debts, thus depriving the county governments of recording fees. That claim—the only one before us—has no merit.” 735 F.3d at 734-35. (13)

MERS has had a lot of success in cases like this, but the fact remains that it was implemented in a flawed fashion with little to no input from a broad range of constituencies. Regulators and legislators should pay renewed attention to MERS to ensure that the ownership and servicing of residential mortgages are tracked in a way that protects consumers from abusive behavior by sophisticated mortgage market players who rely on opaque mechanisms like MERS.

First-Time Homebuyers, You’re Okay

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Saty Patrabansh of the Office of Policy Analysis and Research at the Federal Housing Finance Agency has posted a working paper, The Marginal Effect of First-Time Homebuyer Status on Mortgage Default and Prepayment.

While this is a dry read, it yields a pretty important insight for first-time homebuyers: you’re okay, just the way you are! The abstract reads,

This paper examines the loan performance of Fannie Mae and Freddie Mac first-time homebuyer mortgages originated from 1996 to 2012. First-time homebuyer mortgages generally perform worse than repeat homebuyer mortgages. But first-time homebuyers are younger and have lower credit scores, home equity, and income than repeat homebuyers, and therefore are comparatively less likely to withstand financial stress or take advantage of financial innovations available in the market. The distributional make-up of first-time homebuyers is different than that of repeat homebuyers in terms of many borrower, loan, and property characteristics that can be determined at the time of loan origination. Once these distributional differences are accounted for in an econometric model, there is virtually no difference between the average first-time and repeat homebuyers in their probabilities of mortgage default. Hence, the difference between the first-time and repeat homebuyer mortgage defaults can be attributed to the difference in the distributional make-up of the two groups and not to the premise that first-time homebuyers are an inherently riskier group. However, there appears to be an inherent difference in the prepayment probabilities of first-time and repeat homebuyers holding borrower, loan, and property characteristics constant. First-time homebuyers are less likely to prepay their mortgages compared to repeat homebuyers even after accounting for the distributional make-up of the two groups using information known at the time of loan origination.

So, just to be clear, being a first-time homebuyer is not inherently risky. Rather, the risks arising from transactions involving first-time homebuyers are the same as those involving repeat homebuyers:  loan characteristics, property characteristics and other borrower characteristics.

Wednesday’s Academic Roundup

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