Tag Archives: underwater

Reset Tsunami

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Cyclone home

Newsday quoted me in When Home Equity Lines of Credit Reset when your plan resets. It reads,

A decade isn’t really a long time – just ask the millions of homeowners whose 10-year-old home equity lines of credit are resetting.

There are two types of HELOC resets: Variable interest rates can reset, and an interest-only repayment plan can reset to amortize. That means payments will switch to include principal and interest, explains David Reiss, a law professor specializing in real estate at Brooklyn Law School.

Many are in for a shock. If you’ve been making interest-only payments for 10 years, “the switch to amortizing over the compressed 20-year period [remaining on a 30-year loan] can lead to an increase of 100 percent or more,” says Peter Grabel of Luxury Mortgage Corp. in Stamford, Connecticut.

If your HELOC is resetting, know what to expect.

“You will no longer be able to draw on the equity line,” says Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage.” You’ll have a specific time to pay off the loan.

Consider your goals: “What is your purpose for having a HELOC?” says Ray Rodriguez of TD Bank in Manhattan. That drives the options.

Plan for change: “Prepare for the end of the draw period. Find out what your new payment will be,” says Kevin Murphy of McGraw-Hill Federal Credit Union in Manhattan. Cut expenses to make up for the jump.

Explore options: Consider refinancing your debt into a longer-term fixed-rate loan, suggests Ben Sullivan of Palisades Hudson Financial Group in Scarsdale. Replace the HELOC with a new one, or combine your first mortgage with your HELOC into a new interest-only ARM. Talk to a mortgage counselor.

HELOC vs. Cash-out Refinance for Card Debt Repayment

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CreditCards.com quoted me in HELOC vs. Cash-out Refinance for Card Debt Repayment. It reads, in part,

On paper, it may look as if it makes a lot of sense to replace high interest card debt with a low interest payment if you have home equity you can tap into. If it’s available and will ease your pay-off pain, why not use it, right?

While using a home equity line of credit (HELOC) or cash-out refinance (in which you refinance your mortgage, but tack on an additional cash payout) to rectify your debt woes might seem like a no-brainer, there are lots of factors to consider to determine which avenue is right for you or if you should go that route at all.

“One size doesn’t fit all,” says Malcolm Hollensteiner, director of retail lending sales at TD Bank. “Utilizing equity to pay down or eliminate higher interest rate consumer debt can be a very beneficial strategy, but it should be done in moderation, accessing some — not all — of your equity,” he says.

Gone are the days when banks allowed homeowners to tap into 125 percent of their home value (thanks to the lessons learned during the real estate market meltdown, which left many people “underwater,” owing more on their home loans than the value of the home). And, you’ll need to have a respectable credit score to qualify. But even with more restrictions in place now than in years past, borrowers still should tread carefully if they’re contemplating borrowing against their home.

“Although the interest rates are much lower on a HELOC or cash-out, the issue becomes that you’re taking your short-term debt and turning it into something you’re going to be paying back for 30 years,” says John Walsh, CEO of Total Mortgage Services.

And then there’s the risk factor. Before you jump on that lower rate, you have to understand that if you cannot keep up with your new payments, you risk going into foreclosure, warns David Reiss, professor of law and research director of the Center for Urban Business Entrepreneurship at Brooklyn Law School, who also writes the REFinBlog. “In other words, you are getting the lower rate in exchange for putting up your house as collateral for the debt,” he says.

With stakes this high, it’s not as simple as using a HELOC or cash-out refinance as your “get out of debt free” card. Here are the factors you need to consider.

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As you consider your options, think about both the short-term and long-term benefits and costs, says Reiss. “You can’t think of home equity as free money. That’s your retirement, money you may leave to your children or use for an emergency. It’s money that your future self may need,” he says. If you do decide to move forward, make sure you’re using your home equity wisely — paying off your debt would fall into that category, as long as you commit to smart spending habits moving forward.

Take an honest assessment of where you are in life, and think through your ability to pay off the debt in whatever form it may take. “Run some numbers, and talk this through with someone whose financial judgment you trust,” says Reiss. By being honest with yourself and becoming an educated consumer, you can figure out which option makes the most sense for you.

What Do People Do When Mortgage Payments Drop?

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I went to an interesting presentation today on a technical paper, Monetary Policy Pass-Through: Household Consumption and Voluntary Deleveraging. While the paper (by Marco Di Maggio, Amir Kermani & Rodney Ramcharan) itself is tough for the non-expert, it has some important implications that I discuss below. The abstract reads,

Do households benefit from expansionary monetary policy? We investigate how indebted households’ consumption and saving decisions are affected by anticipated changes in monthly interest payments. We focus on borrowers with adjustable rate mortgages originated between 2005 and 2007 featuring an automatic reset of the interest rate after five years. The monthly payment due from the average borrower falls by 52 percent ($900) upon reset, resulting in an increase in disposable income totaling tens of thousands of dollars over the remaining life of the mortgage. We uncover three patterns. First, the average household increases monthly car purchases by 40 percent ($150) upon reset. Second, this expansionary effect is attenuated by the borrowers’ voluntary deleveraging, as a significant fraction of the increased income is deployed to accelerate debt repayment. Third, the marginal propensity to consume is significantly higher for low income and underwater borrowers. To complement these household-level findings, we employ county-level data to provide evidence that consumption responded more to a reduction in short-term interest rates in counties with a larger fraction of adjustable rate mortgage debt. Our results shed light on the income channel of monetary policy as well as the role of debt rigidity in reducing the effectiveness of monetary policy. (1)

The paper cleverly exploits

the anticipated changes in monthly payments of borrowers with adjustable rate mortgages (ARMs) originated between 2005 and 2007, with a fixed interest rate for the first 5 years, which is automatically adjusted at the end of this initial period. These cohorts experience a sudden and substantial drop in the interest rates they pay upon reset, regardless of their financial position or credit worthiness and without refinancing. These cohorts are of particular interest because the interest rate reduction they experienced is sizeable: the ARMs originated in 2005 benefited from an average reduction of 3 percentage points in the reference interest rate in 2010. (3)

I will leave it to individual readers to work through how they designed this research project and move on to its implications:

The magnitude of the positive income shock for these households is large indeed: the monthly payment falls on average by $900 at the moment of the interest rate adjustment. Potentially, this could free up important resources for these indebted and mainly underwater households. We show that households increase their car purchase spending by more than $150 per month, equivalent to a 40 percent increase compared to the period immediately before the adjustment. Their monthly credit card balances also increase substantially, by almost $200 a month within the first year after the adjustment. Moreover, there is not any sign of intertemporal substitution or reversal within two years of the adjustment. . . . However, we also show that households use 15% of their increase in income to repay their debts faster, almost doubling the extent of this effort. (38-39)

There are all sorts of interesting implications that follow from this study, but I am particularly intrigued by its implications for “debt rigidity — the responsiveness of loan contracts to interest rate changes.” (6) While the authors are interested in how debt rigidity can impact monetary policy, I am interested in how it can impact households. There is much in the American housing finance system that keeps households from refinancing — high title insurance charges and other fees, for instance — but we do not often focus on the impact that rigid mortgage contracts have on the broader economy. This paper demonstrates that the effects are not borne by consumers alone. This paper quantifies the effects on the consumer economy to some extent and reveals that they are quite significant. Policy makers should take note of just how significant they can be.

Strip-Downs Are Good

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The Philadelphia Fed has posted a Working Paper, Using Bankruptcy to Reduce Foreclosures: Does Strip-Down Of Mortgages Affect The Supply of Mortgage Credit? The paper’s abstract reads,

We assess the credit market impact of mortgage “strip-down” — reducing the principal of underwater residential mortgages to the current market value of the property for homeowners in Chapter 7 or Chapter 13 bankruptcy. Strip-down of mortgages in bankruptcy was proposed as a means of reducing foreclosures during the recent mortgage crisis but was blocked by lenders. Our goal is to determine whether allowing bankruptcy judges to modify mortgages would have a large adverse impact on new mortgage applicants. Our identification is provided by a series of U.S. Court of Appeals decisions during the late 1980s and early 1990s that introduced mortgage strip-down under both bankruptcy chapters in parts of the U.S., followed by two Supreme Court rulings that abolished it throughout the U.S. We find that the Supreme Court decision to abolish mortgage strip-down under Chapter 13 led to a reduction of 3% in mortgage interest rates and an increase of 1% in mortgage approval rates, while the Supreme Court decision to abolish strip-down under Chapter 7 led to a reduction of 2% in approval rates and no change in interest rates. We also find that markets react less to circuit court decisions than to Supreme Court decisions. Overall, our results suggest that lenders respond to forced renegotiation of contracts in bankruptcy, but their responses are small and not always in the predicted direction. The lack of systematic patterns evident in our results suggests that introducing mortgage strip-down under either bankruptcy chapter would not have strong adverse effects on mortgage loan terms and could be a useful new policy tool to reduce foreclosures when future housing bubbles burst.
This paper seems to cut through some of the hyperbole that surrounds this topic. Its concluding paragraphs indicate how a modest introduction of strip-downs would have only a modest impact on the availability of mortgage credit. It contrasts such a modest step with more far-reaching proposals, such as using eminent domain to take underwater mortgages throughout an entire jurisdiction. The paper seems to argue that the more modest proposal could be acceptable to the lending industry. I am not so sure that that is true, particularly in the current political environment. But it is certainly true that strip-downs could be a useful tool to have when “future housing bubbles burst,” as they most certainly will.

Reiss on Paying off Underwater Mortgages

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MainStreet.com quoted me in What Bills Should You Pay First? It reads in part,

Consumers started prioritizing their mortgage payments ahead of their credit card payments as of September 2013, according to a new TransUnion study.

This reverses a trend that began in September 2008 when the mortgage crisis drove consumers to pay their credit cards bills ahead of mortgages. Consumers have placed an emphasis on paying their auto loans before their mortgages and credit card payments by a wide margin – since at least 2003, TransUnion said. The study obtained anonymous consumer information from December 2002 through December 2012, and each monthly sample included about 2.5 million consumers.

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Many consumers were faced with devaluing home prices and chose to preserve their credit line, said David Reiss, professor of law at Brooklyn Law School in New York.

“The underwater mortgage may have seemed like a sinkhole when prices were dropping and putting limited funds into it might have seemed like throwing good money after bad,” he said. “When a household’s income can’t cover all of its expenses, it has to prioritize its payments. If the mortgage is underwater, it may make sense to use those limited funds to protect assets that are integral to daily living and wage earning like an auto or to focus on tools like credit cards that may have some use going forward, if there is still any available credit left.”

Homeowners have reversed that logic with the rebound of housing prices, Reiss said.”If homeowners have equity in their home from those rising prices, prioritizing the mortgage protects that equity and keeps the household in the house to boot,” he said. “Not everyone makes such a calculation, but many do.”

Reiss on Rising Interest Rates

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ABC News quoted me in Small Interest Rate Changes Mean Big Money for Home Buyers.  The story reads in part,

As the economy continues to recover from the worst recession since the 1930s, mortgage interest rates remain at historically low levels.

The Primary Mortgage Market Survey, produced by Freddie Mac, reported in mid-March the average rate for 30-year fixed-rate mortgages was 4.32 percent; 15-year fixed-rate mortgages averaged 3.32 percent and interest rates 5-year Treasury-indexed hybrid adjustable rate mortgages averaged 3.02 percent. Nonetheless, Frank Nothaft, chief economist for Freddie Mac, speculated the Fed’s gradual tapering of its stimulus efforts may prompt a rise in mortgage interest rates.

If mortgage interest rates do rise significantly in the future, what, if any effect will there be on the home buying market? According to Steve Calk, chairman and Chief Executive Officer of The Federal Savings Bank, interest rates have never been the deciding factor for whether potential home buyers actually purchase a home.

“Whether interest rates are 5.5 percent or 7.5 percent, when people are ready to buy, they’ll buy a home,” Calk said.

Price, location, size, appreciation value – these are factors many would-be homeowners consider long before mortgage interest rates enter into the picture. However, once they begin actively searching for a home, interest rates often play a role in their ultimate buying decision.

This is especially the case when interest rates are high, according to David Reiss, Professor of Law at Brooklyn Law School.

“When people think about buying houses, they think about the price of the house. But what they really should be thinking of are the monthly costs. The average 25-year-old might not think about housing rates until they go to a mortgage broker.
“Then they discover that 8 percent interest may mean that instead of a $200,000 home they can only afford a $160,000 home,” Reiss said.

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Tight credit and persistent high unemployment have almost certainly played a role in depressing home buying figures during the recovery, as has the large numbers of home owners who perhaps bought homes at the height of the bubble who now find themselves underwater on their mortgages. However, many underwater homeowners could be missing out on a unique opportunity presented by the present financial climate. In a housing market where prices are depressed and borrowing is cheap, home buyers with solid incomes and good credit can find lenders willing to extend credit on favorable terms, ultimately putting them ahead financially, even if they sell their present homes at a loss, according to Reiss.

“Many people feel stuck in place because they are underwater or the market is bad. But although it may be counterintuitive, it could actually be a smart move to sell in a bad market. It’s a bit more sophisticated strategy, but you could move out of a cheap home into a better home for not that much money,” Reiss said.

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Education and due diligence in maintaining good credit are the most potent tools that potential home buyers can employ, whether they are seeking their first home, a larger home or are scaling down to smaller quarters as empty nesters. Obtaining prequalification can provide home seekers with a better idea of precisely how much house they can afford, Reiss said.