The final mortgage innovation
Steve Heller
steve@steveheller.com
Mar
1, 2004
I've been following
recent occurrences in the mortgage market with bemusement. When
I got a mortgage, in the olden days of 1998, you actually had
to put down 20% if you didn't want to have to buy "private
mortgage insurance," which increased your monthly payment.
Recently, of course, this old-fashioned requirement has been
dropped, "to make homeownership available to more people."
Housing prices have been soaring for the last five years, so
the monthly payment may not be affordable to many people even
if they don't have to make a down payment. One "solution"
to this problem has been around for a while: adjustable-rate
mortgages. This reduces the monthly payment at the beginning,
while exposing the buyer to the risk of tremendous increases
in the payment amount after the initial low rate period is over.
But there are still people who can't afford houses anywhere near
where they work, even with adjustable-rate mortgages to "help."
So the next round of innovations was unleashed: interest-only
mortgages. This reduces the initial monthly payment by about
20% compared to a thirty-year conventional loan. Of course, this
"saving" might be considered somewhat expensive, since
it means that you still owe as much money on the mortgage after
five years as you did at the beginning, but after all the name
of the game is "affordability," i.e., the lowest possible
initial monthly payment.
However, even this was not enough to keep housing "affordable,"
given the absurd prices reached in many markets such as California
and the Northwest. There, you can easily spend $500,000 to buy
a modest home on a small lot 30 minutes from work. We know that
everyone has to buy a house, to keep the housing bubble going,
but how?
The next step was, according to someone I heard on CNBC a couple
of weeks ago, to allow people to devote more than the "traditional"
28% of their income to housing. In fact, I was somewhat surprised
to learn that "technology" made it possible for people
to have mortgage payments upwards of 40% of their income. But
who can argue with technology?
Even this, however, is not enough to guarantee the perpetuation
of the bubble. The next stage in the insanity has already been
implemented: the "pay option ARM." This loan (issued
by Washington Mutual, possibly among others) starts out with
a ninety-day introductory period at a very low interest rate,
such as 1.75%. After that, the interest rate rises to an "ordinary"
adjustable rate such as 5.25%. But here's the good part: the
borrower continues paying as though the interest rate were still
at the introductory level! The magic here can be explained by
the seemingly technical term "negative amortization."
What this means, in English, is that you owe more on the mortgage
every month rather than less... but it does lower your payments
temporarily.
But the fun comes to an end eventually, since the lending institution
does not allow you to run up the mortgage amount indefinitely.
When you get to 25% above your original loan amount, they require
you to actually make a large enough payment to keep the interest
from accumulating further. This could put a big crimp in your
budget if you had already taken advantage of "technology"
by spending 40% of your income on your mortgage payment, since
the new payment would probably be about three times the original
payment, or 120% of your income. But it does allow you to buy
a much more expensive house that you can actually afford, so
it has to be considered a success on that basis.
The final solution
I think the institutions offering these loans are pikers. They
aren't seeing the big picture.
Here's my solution to the housing crisis: the no-pay mortgage.
As with most great ideas, it is very simple. They simply lend
you all the money to buy the house, with no foolishness like
down payments or the like, allow the interest to accumulate until
you sell the house, and then collect their money. What could
be simpler?
Let's look at all the advantages of this plan:
1. Very low
administrative costs after the initial loan is made. No one has
to keep track of payments, amounts owed, or the like.
2. The loan can never become "nonperforming." Since
no payments are due, they cannot possibly be late. Therefore,
the lending institution does not have to worry about the soundness
of the loan.
3. Removal of all concerns about the price of housing. No matter
how much the house costs, you can always afford it. Thus, house
prices will never go down.
I'm sure the
building industry would love this idea, as it guarantees an infinite
demand for housing. It will stimulate the economy by providing
jobs in construction, and insure that everyone has a house to
live in. And since it guarantees that real estate will never
go down, the loans entail no risk to the lending institutions.
I guess I should make sure that the Nobel Prize committee has
my telephone number...
When do they
give out the awards for economics?
Steve Heller
steve@steveheller.com
Mar 1, 2004
http://www.steveheller.com
Author of "C++: A Dialog," "Optimizing C++," and other books
Full-text online versions of "Who's Afraid of Java?"
and "Optimizing C++" are now available at http://steveheller.com/whosjpdf/whosjava.pdf and http://www.steveheller.com/opt
321gold Inc
Miami USA
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