A new twist on the Carrying a Mortgage debate

[Hamlet]

I think that the people that have been against paying down a mortgage so that they could invest the difference should re-think things given our liquidity crisis.

Patriotic people should pay down their mortgage to free up that capital for banks to lend out.

I'm only half joking. I think I'll up my principle payments a little, even though my mortgage is only 5.5%. Of course, that beats the T-bill return by quite a bit, now

 

[BunsGettingFirm]

I not a very principled person, so I do not need to pay down any principles, but on the other hand, principals do need to be paid.

 

[samclem]

I was thinking about this yesterday. Rates are going to go up, do the banks really want all these 5-6% mortgages on their books, if they could encourage people to pre-pay and re-loan the money at higher rates? I'm wondering if there won't be some kind of extra pre-payment enticement from the banks to get folks to do this. Anyone know of a precedent?

 

[brewer12345]

I think quite the opposite is what the Treasury was trying to accomplish by nationalizing Fannie & Freddie. They were clearly hoping that the move would push MBS spreads down and therefore push down mortgage rates. If that happens you will see refinancing en masse and a lot of these mortgages will get recycled.

 

[harley]

I not a very principled person, so I do not need to pay down any principles, but on the other hand, principals do need to be paid.

- I've been trying not to get the grammar thread going again, but between the "paying the principles" and the "peeking my interests" I've been struggling to keep the red pen in the drawer.

 

[jIMOh]

I think quite the opposite is what the Treasury was trying to accomplish by nationalizing Fannie & Freddie. They were clearly hoping that the move would push MBS spreads down and therefore push down mortgage rates. If that happens you will see refinancing en masse and a lot of these mortgages will get recycled.

I had been thinking this too over last several weeks.

Lowering the interest rates helped any loan which was tied to prime, but did not help refinance that loan off the books- mortgage rates actually went up when rates went down.

So the powers that be needed to concoct another way to force mortgage rates to drop so that refinancing the bad debt (to become less bad debt?) is possible.

Which leads me to my question:

If person A took out loans 1 and 2 for a house they may or may not be able to afford and loans 1 and 2 are considered risky... then if person A takes out loans 3 and 4 for a house they may or may not be able to afford- what makes loans 3 and 4 any less risky than loans 1 and 2?

HMM.

 

[harley]

I had been thinking this too over last several weeks.

Lowering the interest rates helped any loan which was tied to prime, but did not help refinance that loan off the books- mortgage rates actually went up when rates went down.

So the powers that be needed to concoct another way to force mortgage rates to drop so that refinancing the bad debt (to become less bad debt?) is possible.

Which leads me to my question:

If person A took out loans 1 and 2 for a house they may or may not be able to afford and loans 1 and 2 are considered risky... then if person A takes out loans 3 and 4 for a house they may or may not be able to afford- what makes loans 3 and 4 any less risky than loans 1 and 2?

HMM.

Precisely. In actuality, anyone who is holding a risky loan they can't afford to pay would never be approved in today's less frivolous credit markey. So the only people who could refi are people who are already going to pay off their higher rate loans. This plan would end up costing the banks money, not creating a flow of money for credit use.

 

[soupcxan]

Mortgages are a funny thing from the bank's point of view. If rates go up, no one wants to refinance, but the value of those mortgage assets drops because investors would rather earn the market yield rather than the mortgage yield. On the other hand, if rates drop, everyone rushes to refinancing their mortgage and the banks are stuck with a bunch of cash that they now have to reinvest at lower rates. It's tough.

Contrary to what the government hoped to acheive with FNM/FRE, banks are using this situation to increase the spread between their cost of funds and their interest income (net interest margin). They need their loans to be more profitable to cover all the losses they're taking or anticipating. So rates to the end consumer have actually gone up. In the long run, this could be positive for the earnings of whichever bank is left standing.

 

[Bestwifeever]

Interesting. I was thinking over the past couple of weeks that in the "Leave It to Beaver" and "Ozzie and Harriet" golden days everyone's goal was to be mortgage free. Maybe part of our economic problem is lumping our personal home mortgages in with our other investments, treating our homes as piggy banks, etc. Maybe we should get rid of HELOCs and refinancing and all the mortgage interest deductions and make free and clear home ownership a national goal instead of a mortgaged home.

When we bought our house in 1978 our bank said they were not in the business of refinancing ANY mortgages.

 

[cute fuzzy bunny]

investors would rather earn the market yield rather than the mortgage yield.

I wonder how thats worked out for folks over the last ~10 years...

 

[jIMOh]

I am in an interesting position on this.

In 2003 wife and I put a deposit down on a new construction home in Ohio. Builder said we would move in in April and I said I wanted to close in June. Builder said April, I said June. Builder said April I said I want my money back. We got our money back and walked away. The price of that house was 275k.

In 2005 wife and I went back to same neighborhood. Our balance sheet was much better. June 2003 was when my car loan was paid off. The additional year also allowed some student loan debt to be paid off. We were debt free moving into house in 2005. We moved into same neighborhood with same builder and built the same floorplan with same options as before. House cost was now $350k.

House price went up 28% in 18 months. We refinanced the loan about 8 months later (June of 2006) and house was appraised even higher.

I highly doubt we could get the 350k for our house now. Confident we could get the 275k, but we would lose much money on that deal.

So I see this bailout and ask myself- how does this help me, in my situation? Wife and I both work and have good paying jobs. We can afford the current mortgage payment (36% of our net income/ 25% of our gross), but I wonder if walking away actually would benefit us or get the mortgage holder to give us better terms (we have a 5.75% rate).

I am just amazed at the amount of reading I am doing on this that many people say it needs to be fixed before Monday. Why Monday? What will happen if market drops another 20%? Does Vanguard, Fidelity and T Rowe Price have access to enough money to pay for the redemptions a 20% drop would stimulate? Even if people were able to get Vanguard to sell their shares, do they think that their local bank would even be open to get access to the money?

Maybe the end result of all of this is we do most of our banking through swiss bank accounts?

This is more me rambling because I want to go home from work- almost time to go.

 

[kyounge1956]

(snip) Which leads me to my question:

If person A took out loans 1 and 2 for a house they may or may not be able to afford and loans 1 and 2 are considered risky... then if person A takes out loans 3 and 4 for a house they may or may not be able to afford- what makes loans 3 and 4 any less risky than loans 1 and 2?

Well possibly this hypothetical person A could afford the monthly payments at the interest rate they were paying the first year of their ARM, but when the rate went up found the increased payment too much of a stretch. So if rates go down and person A can refinance with a fixed loan for the same amount at the same rate s/he was paying the first year of the ARM, wouldn't there be less risk that person A will default on the new loan?

If it was one of those negative amortization loans so the balance went up while the rate was low and/or the prices have gone down a lot in the area and the house would now sell for less than the remaining balance on the loan, then I agree—it doesn't look good for person A or their bank.

 

[audreyh1]

I am just amazed at the amount of reading I am doing on this that many people say it needs to be fixed before Monday. Why Monday? What will happen if market drops another 20%? Does Vanguard, Fidelity and T Rowe Price have access to enough money to pay for the redemptions a 20% drop would stimulate? Even if people were able to get Vanguard to sell their shares, do they think that their local bank would even be open to get access to the money?

It may be because Tuesday Sept 30 is the end of the quarter, and financial institutions get to go through the whole mark-to-market rigamarole again. Now with even more depressed assets. I guess the feeling is that unless the Govt becomes a market for some of these distressed assets, several more institutions will fail.

Also the credit squeeze is making thing difficult for non-financial businesses. I guess the longer this credit squeeze drags on, the more (as in larger number of) businesses are put at risk.

Audrey

 

[Finance Dave]

I was thinking about this yesterday. Rates are going to go up, do the banks really want all these 5-6% mortgages on their books, if they could encourage people to pre-pay and re-loan the money at higher rates? I'm wondering if there won't be some kind of extra pre-payment enticement from the banks to get folks to do this. Anyone know of a precedent?

How do you know rates are going up?

 

[samclem]

How do you know rates are going up?

I sure don't know, but:
1) I can't believe they'll go down from my present 5% mortgage. That's the lowest they've been in decades.
2) They got that low because a bunch of cash was pumped into the MBS market. Folks are a lot less willing to put their money into these now.
3) Unless the government pumps a bunch of bailout money into the system (making it available use for commercial paper loans), businesses will need to find a place to get their money. That source could very well be--banks. If banks have greater demand for their pool of available lending cash, I'd guess they'll charge more for it. And, if they can charge more for it--maybe they'd be willing to sweeten the deal for me to give them a wad of cash and pay off my low-rate mortgage.

But, these are the speculations of a rank amateur.

 

[virginia]

Interesting. I was thinking over the past couple of weeks that in the "Leave It to Beaver" and "Ozzie and Harriet" golden days everyone's goal was to be mortgage free. Maybe part of our economic problem is lumping our personal home mortgages in with our other investments, treating our homes as piggy banks, etc. Maybe we should get rid of HELOCs and refinancing and all the mortgage interest deductions and make free and clear home ownership a national goal instead of a mortgaged home.

When we bought our house in 1978 our bank said they were not in the business of refinancing ANY mortgages.

I think that's because sometime in the past 10 years, people quit listening to their own little voice inside that says owning your own home is the way to go, and started listening to the media/their advisors/whoever that said that carrying a mortgage is good for a "tax deduction." Honestly I can't tell you how many people who have told me that I should carry a mortgage (including my advisor) instead of paying it off, and instead paying tax on the rental income. Crazy.

 

[plex]

Why would you pay of a mortgage now? It may make you feel better in the short term, but it probably is not going to help you in the long term (as long as you expect to be able to meet your mortgage payments, e.g. your mortgage isn't over 30% of your take-home income). Paying off your mortgage now means not buying low. True, it isn't as bad as selling low and sticking it under the bed, but it is still pretty bad to take a large chunk or all of your future new investments out of the market, especially when considering the tax break you lose.

The best time to pay off a mortgage is when the market has been doing great, that way, if the market tanks, your new money is missing the big drop instead of missing the big recovery, as is the case when you pay of your mortgage when the market is obviously doing poorly.

 

[BunsGettingFirm]

Why would you pay of a mortgage now? It may make you feel better in the short term, but it probably is not going to help you in the long term (as long as you expect to be able to meet your mortgage payments, e.g. your mortgage isn't over 30% of your take-home income). Paying off your mortgage now means not buying low. True, it isn't as bad as selling low and sticking it under the bed, but it is still pretty bad to take a large chunk or all of your future new investments out of the market, especially when considering the tax break you lose.

The best time to pay off a mortgage is when the market has been doing great, that way, if the market tanks, your new money is missing the big drop instead of missing the big recovery, as is the case when you pay of your mortgage when the market is obviously doing poorly.

My house is <20% of my NW, so why not pay it off? It's not because I'm rich; it's because I'm extremely cheap. I have the vast majority of the rest riding in stocks.

 

[cute fuzzy bunny]

Paying off your mortgage now means not buying low.

That would be true if you were going to sell the most depreciated equities you own to pay it off. Might not be true if you're using fixed income holdings that arent returning crap right now. Then with that big payment off your back and a reduced withdrawal rate, you wont need to sell so many depreciated assets to make the mortgage payments.

Its pretty tough to get a 5-6% completely risk free return right now...

But you're also right in that the time to do this was 2 years ago when equities had been on a 4 year run. But everyone is so excited about making money off of their arbitrage when thats going on that it never looks like a good idea.

Sort of like how people werent that interested in the 6.25% 5 and 7 year CD's you could have picked up a year or two ago, but now they'll throw money at a failed bank to get 5%. Ya have to think ahead and out of the current moments conditions.

 

[OAG]

Actually FED rates may decline. There is news (CNN) about a "quick drop in Fed rates" before the next Oct FOMC meeting "to help the market". Fed rate does not influence Mortgage rates directly (maybe not indirectly; since current Mortgage rate spread versus Fed rate is pretty wide). Additionally, there is NOTHING that I can see in this BAILOUT that is going to help homeowners recover a penny of the decline in home values and IMHO nothing that is even going to slow the decline. All of this indecision and the unknowns in the financial market is tending to "freeze up" everyone - no move becomes the "best" move lest we make the "wrong" move. BTW Capital One has FDIC insured CD's in the 7 or 10 year range paying 5.4% APY - long term but safe.

 

[samclem]

Another factor is the (likely) expiration of the favorable treatment of cap gains (or even the early termination of these more favorable rates, depending on the outcome of this election). The clock is ticking either way. For many people, if they decide to wait for the market to recover, they are essentially betting that it will recover and that it will do so before the cap gains tax rates go up.

Another impact of the pending increase in cap gains taxes: As the end of the favorable rates draws near, people will be selling off their appreciated assets to take advantage of the lower rate. Some people will do something close to a wash sale, just resetting their basis and buying similar equities. But others will use this opportunity to instead lessen their exposure to stocks. That won't help stock prices.

 

[laurence]

I think quite the opposite is what the Treasury was trying to accomplish by nationalizing Fannie & Freddie. They were clearly hoping that the move would push MBS spreads down and therefore push down mortgage rates. If that happens you will see refinancing en masse and a lot of these mortgages will get recycled.

A little over 3 years ago I refi'ed into a 20 year @ 5.125% and have been paying extra to boot. Do you think the goal is to get rates below this? Is it possible I could get a 15 year loan with the same payment if Paulson gets his way?

 

[haha]

I think that's because sometime in the past 10 years, people quit listening to their own little voice inside that says owning your own home is the way to go, and started listening to the media/their advisors/whoever that said that carrying a mortgage is good for a "tax deduction."

I'm in my 60s and I can't remember a time when many people were interested in paying off their mortgages. And most of the time they were right.

Ha

 

[cute fuzzy bunny]

I'm guessing that may largely be because they were accumulators and not ER's, they werent experiencing the sort of financial turbulence we've "enjoyed" over the last 10 years, and...because they couldnt?

 

[virginia]

I'm in my 60s and I can't remember a time when many people were interested in paying off their mortgages. And most of the time they were right.

Ha

I do - my grandmothers Dad bought his land for cash and built himself as he could pay for it. My grandparents built their house and owned it free and clear as soon as they could, and I guess my Dad had his paid off by his mid forties.

And not until the past 20 years or so, and definitely not common until the past 10 -15 years or so could you just pull a line of credit on your house and just buy anything that you wanted with it.