In the current foreclosure crisis, many of the mortgage-modification proposals I’ve heard of seem ineffective, if not actually harmful to the homeowners (as in, increasing their monthly payment). So I find myself asking why banks can’t rewrite troubled mortgages as, say, 100-year mortgages, rather than the current 15-, 20- or 30- year mortgages. This would cut the monthly payments for the homeowner, while keeping the loan viable.
So two questions: Is this a workable idea? And if so, has it been proposed or implemented anywhere?
A modest, $100,000 mortgage at 6% for 30 years has a $599.55 payment, and a lifetime repayment of $215,838.19 (a cost of $115,838.19). That same mortgage and simple rate for the course of 100 years has a payment of $501.26, and a lifetime repayment of $601,513,45 (i.e., a cost of $501,513.46).
The less than $100 drop in payment is negligible versus the $385,000+ increased cost of the loan.
The problem is that with typical 30-year loan, most of your monthly payment goes to paying interest at the start of the loan period. You can’t get below that interest payment, unless you want the loan to increase indefinitely. On a $100,000 mortgage at 6%, interest at the start is $500 per month.
Balthisar, I trust your math, but I’ll just say two things about it – one, most troubled mortgages I imagine are for higher than $100,000, so you’d get higher monthly savings (and yeah, it’s possible that the savings aren’t enough to make the difference between viability and non-viability); and two, I’d expect that the homeowner would refinance after a few years when his/her finances improve, getting more of a conventional mortgage and better equity accumulation. Or they’d sell. But in either case, the total lifetime repayment costs won’t come into play.
The reason people are walking away from their mortgages is that the house isn’t worth what they paid for it any more. It isn’t necessarily that people can’t pay their mortgages, as that they see no point in doing so. Increasing the term of the mortgage doesn’t change that (except in the minor sense that in a hundred years, property values will probably have recovered.)
Not to mention that in the past couple of years, interest rates have plummeted, so that if saving a couple of hundred dollars/month was all that was necessary to keep the house, then refinancing could probably achieve that.
Your idea isn’t any different than the interest-only plans. When you say “extend the term”, that’s exactly the same thing as “pay less principal”. The term of the loan is an effect of how much principal is paid every month.
So take your 30-year mortgage and slide that out to 60 years. Now you’re paying less principal. Take it and slide that out to your 100-year idea. That’s now a $599 payment down to $500. Now slide that out to infinity. That’s an interest-only payment.
There was a lot of talk about this back in the stagflation years of the 1970s, when interest rates approached 20%. I’m sure I remember that 99-year mortgages were common in Canada at the time, since they were having the same problems. (There’s usually a technical legal difference that allows 99-year liens but not 100-year ones that I can’t remember the details of.)
But that’s not a good solution today because the conditions are different. People are walking away from homes because their current payments are twice or more as high than what they could find for equivalent houses with the new smaller price tags. That’s $1000 or more in monthly payments.
At 6% you’d need to have a million dollar mortgage to get that much payment relief. Very few of the underwater homeowners do. The very long mortgage might make more sense at 20% interest, but that’s not what we have today.
A suggestion I read some years ago seemed good: Let troubled mortgages become market-rate rentals for a few years, with a re-reckoning 5 years or so in the future when uncertainties have cleared up. This would be very complicated, of course, but there are no simple solutions. It would tend to keep the “home-owner” in his home, and thus remove a downward pressure on house prices.
The idea had such a “ring of truth” to it when I read it, I thought it might be pursued. I guess it lacked a specific vested constituency; it helps America and homeowners, but “we need” something that banks, or some other specific campaign-financing industry, can get behind.
Not so. In interest-only loans, you typically pay only the interest for a while, then after a set period, you start paying back principal, resulting in a higher monthly payment. In the scheme I’ve proposed, you’d pay the same every month. Equity would accrue – slowly, but it would accrue.
The objections I see above are that my idea won’t help much. Granted – but until someone shows me that my idea is illegal, immoral or fattening, I’ll continue to think that even if it would help only a small minority of borrowers, it would still be worth pursuing. So there!
Also look at it from the bank’s point of view: The mortgage may be $300k on a house that is now worth $250k. They aren’t going to refinance for any period on those terms. Since mortgages are bundled and resold, who is going to buy a package of mortgages for more than than the property securing them?
And those people not only don’t need mortgage modification, it’s offensive to even allow them to modify their mortgage, just because they wanted to game the real estate system with their McMansion.
Yeah, but the same goes for everyone that’s getting mods and taking part in government programs. Just because it’s not a McMansion to you and I, a $100,000 house to someone who only makes $25,000 is a McMansion to them. They were irresponsible, too.
Piffle. Semantics. A payoff date is just a number derived from how much principal you’re paying every month. When you say “Give them a 99-year loan”, that’s just saying “Make them pay very little principal per month.” A 15 year loan is saying “Make them pay a lot of principal every month.” If it’s an interest only loan, that’s saying “Make them pay no principal every month.” The fact that there’s a changing ratio of interest:principal every month is immaterial.
Imagine a convex curve, like the right half of the top of a baseball or the crust of the earth. The y axis is the principal remaining. The Y axis is time. That’s roughly how a normal 15-year loan looks. If you drag the x intersection out of 30 years, then the curve gets shallower in slope, but it retains its overall shape. As you slide it to 40, then 50, then 60, the slope gets shallower and shallower. It’s still a curve, though. Once you get to infinity, the slope is 0. It’s a flat line. That’s an interest-only loan.
So my point is that your idea is just another “pick a point on the X-axis” idea, and thus, it’s no different than an interest-only loan or even a simple refinance.
It’s certainly true that it’s just another point on the curve, but the whole point of successful mortgages is to find the right point. Every mortgage is obviously on the curve.
Banks already offer a variety of loan lengths. You can probably find 10, 15, 20, 25, and 30-year loans. They do that because different people have different circumstances, needs, and goals.
There’s nothing at all to stop banks from offering longer loans. It’s just that diminishing returns start to set in after 30 years. There may very well be a point between 30 and 99 that makes sense for some and for certain banks to make it available.
It’s just that the extreme of 99 years probably offers too little for both parties for it to be a good idea today, in the U.S., in our circumstances. Other times, other places, other economic climates, it might work. It’s understanding the circumstances that’s important, nothing inherent about the loan length itself.
The problem remains that there’s no way you can change the terms of the current loan such that it wouldn’t be better to simply walk from the deal. The people who are upside have two options: pay x for something that is worth less than x, or walk. The manner in which you pay it is mostly irrelevant - it’s still an NPV negative proposition.
The only thing can change the NPV is a modification of either: the interest rate, the principal, or the value of the home itself (assuming the personal discount rate is equal to the interest rate at which they borrowed, I don’t want this to get too wonky thoguh).
Lowering the interest rate or principal just makes the banks even less solvent (if done by the bank) or subsidizes poor decisions (if done by the government, and not only the buyer’s poor decision, but that of the bank making the loan as well).
Changing the value of the home is difficult - the hope is that home prices increase naturally as supply is reduced due to less building and conversions to apartments and the like. Demand can also be artifically stimulated via tax breaks - but this only props up the price for some time.
The only real solution is an economic recovery that boosts the home value prices back up to the point where ownership for the previously upside-down is no longer a losing deal. The only other thing keeping people in place is the cost of walkign - from a credit standpoint or tax incentive or whatever.
Odds are if the guy’s in financial trouble, a 1/6 reduction in payment will do nothing for him. So making it a 99-year mortgage is a waste of time. If it makes things manageable, then he should talk to the bank.
If the house is not worth the mortgage principal, then something has to give - either the owner keeps paying (because he can afford to) or he stops paying and walks away, or the bank takes a write down and eats the difference. If the difference is not too bad, the bank might(??) choose to take a write-down; but once they do that for one customer, they would be pressured to do it for everyone, meaning the bank shareholders (and the fed) get hosed to the benefit of people who over-bought.
If the bank writes down the loan, then they are just taking a short-cut to the same end as selling a foreclosed house for fair market value. The $400,000 house becomes a $200,000 house and the bank/mortgage bond backers are out the difference. All you save is months of legal back-and-forth and the homeowner gets a retroactive discount on their house.
Who do you want to feel the pain? Should those who bought responsibly be paying for the irresponsible people to get bigger and better houses? After all if the banks’ expenses go up, they will raise rates for all their customers. there’s no magical fat cat “them” who pays the difference. It’s you and me, our pension funds and other savings that lose.
How about if you change the principle to the current real value of the home but when the home is sold a large portion of any increase in value goes back to whoever took the hit on the original loan. Perhaps with some sort of time limit where the house is reappraised and the the difference has to be taken care of or the house must be sold?
This idea has been seriously discussed by the Treasury & related powers that be.
For the most bubbleiscious parts of the country, there is no expectation that prices will *ever *recover to the boom time values. At least not in real terms. Those million dollar 1200 sf generic condos in FL will be worth $1mil again about the same time a loaf of bread costs $50.
So a decision to write the principal down to the 80K they’re selling for now is a decision to write off 800K of value forever and keep the hope alive that the price will eventually (in 10+years) appreciate / recover to $150-200K and the bank will get back some / most / all of the gain up from 80. Meanwhile, a loaf of bread has risen to $5 through routine inflation.
If I was a banker I’m hard pressed to see why I should sign up for that.
I see some moral tutt-tutting upthread, as if only greedy over-reaching folks caused this problem. They sure made it worse, but if you bought any real estate anywhere in the US at any price after about 1998 you’re part of the problem. And that includes me.
Not so much you… the people who bought well beyond their ability to pay deserve the tut-tut. The ones who bought exploding ARMs, knew that in a few years they would not be able to pay, tut-tut to them. Anyone who can afford to pay - you bought it, pay for it. Anyone who has lost their job and cannot pay - sorry, you have my sympathy.
Basically, principle loaned needs at least to have the interest paid.
-if the home-owner cannot even pay the interets, the bank is taking a hosing.
-if the bank lowers interest rates below market value, they take a hosing.
-if the bank accepts partial payment, they are taking a partial hosing. if the rest is in a lien on the house, then that amount is essentially an interest-free loan for however long the owner decides not to sell and move. More hosing to bank.
-if the lein goes up to include interest, then odds are it will never get collected, and eventually is worth more than the house - no incentive to home owner to sell and cut the bank’s losses.
Basically, things have to give somewhere, and the ultimate end that settles everything quickly is foreclosure. Everything is over and done with.
Maybe a simple solution is to allow the current owner to make a bid he can afford, if the foreclosure auction fails to sell the house.
I don’t know how often a foreclosure auction gets no satisfactory bids…