Archives For Mortgages

I received an email from Kiplinger’s with these five steps to take before paying off your mortgage early during retirement:

• Pay off consumer debt—given today’s interest rates, you’re probably paying less than 5% on your mortgage, compared with about 13% on credit card balances. Paying credit card debt give you an instant return on your money equal to the rate on your cards—and you can continue to deduct the interest on your mortgage (no such tax break for credit card balances).

• Fuel retirement accounts—the remaining few years before retirement represent your last chance to stash money in tax-advantaged retirement accounts. You’ll waste that opportunity by not maxing out your accounts. An even worse idea is withdrawing money from your IRA to pay off the mortgage.

• Keep a reserve fund—even if you don’t plan to touch retirement savings to pay off the mortgage, be sure to have enough money in your emergency fund to cover six months of living costs; otherwise, you could end up tapping retirement accounts anyway. Also, be mindful you’ll need income in retirement to cover other expenses.

• Weigh return versus risk—if you’re paying 4% on your mortgage and you have nonretirement cash accounts earning less than 1%, retire the mortgage. But, if you think you can earn 6% on your investments and your mortgage costs 4%, keep the mortgage and let your investments grow—assuming you won’t kick yourself if your investment return takes a dive.

• Stay flexible—you could refinance a shorter-term mortgage, saving thousands of dollars in interest. The downside: you would incur closing costs and could also lock yourself into a higher monthly payment, depending on your current interest rate. Consider prepaying your current mortgage each month instead.

You can read the entire article here.

I have always felt that the decision of whether or not a person should pay off their mortgage should be a function of interest rates. The higher the interest rate, the faster it should be paid off. When I can get a mortgage at under 4% and I have no trouble making the payments, it makes little sense to me to worry about paying off my mortgage quickly. Yes, there are benefits other than financial to paying off a mortgage early. Peace of mind is one of them—especially during retirement. I understand that. I guess a person must decide what’s most important to them.

The cover story in this week’s Barron’s is about the housing market.

Nothing’s wreaked quite the havoc on the U.S. economy, and indeed the national psyche, as the six-year slide in home prices. It wiped out some $7 trillion in household wealth, savaged bank balance sheets, and induced the Great Recession and the tepid recovery.

Yet there are unimpeachable signs that this national nightmare is now over. Home prices are starting to rise, if somewhat haltingly, in most areas of the country. And a number of forecasters predict home-price increases around 10% or so nationally over the next three years, with some metropolitan statistical areas, such as Midland, Texas, and Bismarck, N.D., likely riding the energy-exploration boom to better than 20% jumps in residential-real-estate prices. The turnaround, in fact, appears to be arriving exactly on the schedule that Barron’s laid out this year in a March 19 cover story entitled “Ready to Rebound.”

Of course, it’s not all optimistic…

TO BE SURE, any sustained recovery in prices faces some formidable obstacles. The “shadow inventory” of residences that are in some stage of foreclosure or whose owners are at least 90 days delinquent on their mortgages stands at 3.1 million–6% of the 50 million home loans in the U.S. In a normally functioning market, the total of distressed properties would be more like 2%.

Likewise, some 13 million homeowners are under water — meaning that their mortgages are larger than the value of their houses or condos. Although the vast majority of these people are current on their mortgage payments, many may be tempted to resort to a “strategic default.” This is particularly true in the event of a job loss or some other economic vicissitude.

And finally, the collapse in housing prices was so severe — nationally, residential real estate fell by over one third in value, peak-to-trough — that it would take at least a 50% jump just to restore prices to the nutty levels they achieved in 2006. Unfortunately, those were the prices at which many homes were purchased. So, for many, hope will be difficult to maintain in the years ahead.

This one quote from the article bugs me because it was this mentality that helped cause the housing bubble in the first place:

“We’ve clearly reached a key psychological shift in home buyers’ psychology, where folks are now starting to worry about missing the boat, rather than fearing whatever house they buy, no matter how attractive the price, can only go down in value,” [Mark] Zandi explains.

Interesting piece if you have the time to read it.

Read this over the weekend:

Reviving Real Estate Requires Collective Action

What does he mean by “collective action”? Well, here’s one idea, which I find scary:

ROBERT C. HOCKETT, a Cornell University law professor, has outlined another approach, which uses the principle of eminent domain, to solve this collective action problem. Eminent domain has been part of Western legal tradition for centuries. The principle allows governments to seize property, with fair compensation to owners, when a case can be made that such seizure serves the public interest.

Traditionally, we think of eminent domain law as applying to land and buildings. For example, a government can use eminent domain to seize real estate along a proposed new highway route so the highway can be built in a nice straight line. It would be absurd to expect the government to bargain with each property owner to buy a strip of land along the proposed highway route and to have to redirect the highway around a farm whose owner refused to sell. That is common sense.

But eminent domain law needn’t be restricted to real estate. It could be applied to mortgages as well. Governments could seize underwater mortgages, paying investors fair market value for them. This is common sense too. The true fair market value for these mortgages is arguably far below their face value, given the likelihood of default, with its attendant costs.

Professor Hockett argues that a government, whether federal, state or local, can start doing just this right now, using large databases of information about mortgage pools and homeowner credit scores. After a market analysis, it seizes the mortgages. Then it can pay them off at fair value, or a little over that, with money from new investors, issuing new mortgages with smaller balances to the homeowners. Taxpayers are not involved, and no government deficit is incurred. Since homeowners are no longer underwater and have good credit, they are unlikely to default, so the new investors can expect to be repaid.

The original mortgage holders, the investors in the new mortgages, the homeowners and the nation as a whole will generally be better off. There will surely be some who may not agree, like the holdout farmer opposing the highway, but eminent domain ought to be able to push ahead anyway.

So if eminent domain can move from land and buildings to mortgages, where else could it move to? I don’t know about you guys but this scares me.

But, beyond that, how would such a strategy work? Seems like a confusing mess once you consider the fact that we don’t know who owns the mortgages in the first place. And, who are these new investors going to be?

I have said it many times but we should have just let the people’s homes go into foreclosure and let the market it work it out instead of all these “fixes” to try to get people to stay in homes they can’t afford. Let’s get these people out of their homes, let the prices fall to a point where people will buy them again and start over that way. Of course, my way won’t get any votes for politicians.

In today’s WSJ:

The Obama administration is trying to push through a settlement over mortgage-servicing breakdowns that could force America’s largest banks to pay for reductions in loan principal worth billions of dollars.

Terms of the administration’s proposal include a commitment from mortgage servicers to reduce the loan balances of troubled borrowers who owe more than their homes are worth, people familiar with the matter said. The cost of those writedowns won’t be borne by investors who purchased mortgage-backed securities, these people said.


So far, most loan modifications have focused on shrinking monthly payments by lowering interest rates and extending loan terms. Banks, as well as mortgage giants Fannie Mae and Freddie Mac, have been shy to embrace principal reductions, in part due to concerns that many borrowers who can afford their loans will stop paying in the hope of being rewarded with a smaller loan. But some economists warn that rising numbers of underwater borrowers will drag on housing markets and the economy for years unless more is done to help them.

I know I sound like a broken record but I know a better way. Foreclose. It would clear out the system much quicker than all these “fixes” would.

Source: U.S. Pushes Mortgage Deal

Facing Losses

January 21, 2011

My last post brought a passage from Meir Statman’s What Investors Really Want: Know What Drives Investor Behavior and Make Smarter Financial Decisions* to mind regarding the housing market. The passage comes from Chapter 10 – We Want to Face No Losses:

Houses sell quickly in boom times at prices that exceed list prices. Yet in bust times, houses sit on the market for months and years at list prices higher than they could possibly fetch. Many sellers withdraw their houses from the market rather than sell them at prices lower than the prices they have set in their minds. Homeowners say the market is slow, we’ll just hold on and wait. In truth, it is homeowners who are slow. They are slow to reconcile themselves to the fact that today’s reasonable prices are lower than the prices they have set in their minds. Realtors often refuse to represent such reluctant homeowners, knowing that they are not likely to persuade them to reduce their prices and realize their losses.

I think what sets selling a house at a loss apart from selling stocks at a loss is that usually there’s a mortgage involved with a house. If you have a house with a $100,000 mortgage, it would be tough to sell it for $90,000 unless you had $10,000 cash to pay off the rest of the mortgage. My point being that I don’t think people have prices set in their minds but have a “balance sheet” set in their mind and know how much they need to sell their house for in order to make themselves whole.

Taking a house off the market because you can’t get what you want for it, is perfectly reasonable in my mind.

*Affiliate Link

Inflation and Your Mortgage

September 16, 2010

Mark’s comment on yesterday’s post inspired this post. Thanks, Mark!

I have written about the impact of inflation on mortgage payments in the past (see: Your Mortgage May Not Be As Expensive As You Think It Is). The problem with old posts is that they get buried and no one ever reads them again.

The companies (and certain radio and TV personalities) that talk about mortgages and how much interest you pay, aren’t telling you the full story. If you buy a house with a $200,000 mortgage with a 4.75% fixed interest rate for 30-years, they will tell you that you will pay nearly $160,000 in interest alone! In absolute dollar amounts they are correct. But, they are also very wrong because they are not factoring inflation into the equation. Why is inflation important? Well, for several reasons:

1. Inflation usually means that prices will go up over time.

2. Inflation can lead to cost-of-living adjustments (increases) to wages.

3. Meanwhile, the amount you pay on your fixed mortgage stays the same.

What this means is that your payment—although it stays the same dollar amount throughout the mortgage term—it decreases over time due to inflation.

How much?

Of course it depends on the inflation rate. The higher the inflation rate, the cheaper your fixed mortgage becomes over the years. For instance, check out the following four graphics I put together. The first two represent a 30-year mortgage. The first one is with a 3% inflation rate and the second one is with a 4% inflation rate. Notice the difference between the total amount of interest paid and the total amount of interest paid NET inflation. Pretty sizeable difference.

30-Year Fixed Mortgage with 3% inflation

30-Year Fixed Mortgage with 3% inflation

30-Year Fixed Mortgage with 4% inflation

30-Year Fixed Mortgage with 4% inflation

For those interested in 15-year mortages, I ran those numbers too:

15-Year Fixed Mortgage with 3% Inflation

15-Year Fixed Mortgage with 3% Inflation

15-Year Fixed Mortgage with 4% inflation

15-Year Fixed Mortgage with 4% inflation

How did I arrive at these numbers? I did what’s called a discounted cash flow of the mortgage amortization. This is where you take each payment and discount it at the expected inflation rate. You can read Your Mortgage May Not Be As Expensive As You Think It Is to get the math.

What can we take away from this? Well, for one, with interest rates on mortgages as low as they are right now and inflation expected to rise in the future, you might be better off keeping with a long mortgage. The higher the inflation rate, the cheaper borrowed money becomes (as long as you have a good interest rate on the loan).

Those who adamantly suggest that people pay off their mortgages as quickly as possible are missing the big picture.

Larry Swedroe posted an interesting article on how to do the math on a mortgage refinancing to find out whether or not it’s to your benefit to refinance. He used the following example:

• 12 years left on a 15-year mortgage.

• Current mortgage rate is 4.75%.

• Current monthly payment $1,369

• Current balance on the mortgage around $150,000 (this is the amount to be refinanced).

This couple is looking to refinance into:

• 15-year mortgage.

• $150,000 loan.

• $3,000 in closing costs (to be paid upfront).

This couple is in the 25% income tax bracket.

So…based on those numbers, would it be a good idea to refinance?

Well, as Larry points out, there are a lot of things to consider before jumping into a refinance.

1. In this example, the spread between the two interest rates is less than a 100 basis points (less than one percent). Naturally, the bigger the spread, the more advantageous it is to refinance.

2. There is more to the calculation than simply looking at the difference in payments since the payment includes principal, which is your own money. So, we have to look at the difference in the interest portion of the payment.

3. As Larry also points out, interest payments are tax deductible (if you itemize your deductions). Larry uses the 25% income tax bracket for his example. Based on that, the couple is paying $.75 for each $1.00 of interest. Basically, what this means is that this makes the refinance less advantageous (you’ll see this in the spreadsheet).

4. This couple is already three years into their loan. They are looking to refnance into a new 15-year mortgage. That means they have paid 3 years of interest on the old loan and will be paying 15 years of interest on the new loan for a total of 18 years of interest.

5. The closing costs are paid upfront.

After running the example, I came to the conclusion that refinancing this loan will cost an additional $702 in after-tax interest. I arrived at this number by adding up the three year’s of interest paid on the original loan plus the 15 year’s of interest on the new loan. Were they to continue with the old loan, they would have paid a total of $70,417 in interest ($52,812 after-tax in a 25% income tax bracket).

What Larry leaves out, in my opinion, is a discussion of the opportunity cost between the two loans. By choosing to refinance, this couple would be freeing up cashflow that could be put to work elsewhere (unless they are using the cashflow to shore up their budget). The payment difference of $296 per month could be invested elsewhere for the next 12 years. Using a monthly total return on the S&P 500 Index of .75% (including a management fee), that $296 per month payment difference could grow to more than $112,000 in 15 years. If they invested the $3,000 plus the entire $1,369 monthly payment for 3 years after the end of the original mortgage, they would have over $60,000 at the end of 15 years. Another thing worth mentioning is that all of the $296 per month could be put into a Roth IRA where only a portion of the $1,369 payments could be put in a Roth because they would exceed the Roth limits.

Based on those numbers, the refinance looks like a no-brainer. But, I left out three things: 1. Investing in the stock market is not a sure thing and 2. I didn’t make adjustments for taxes, which favored the refinance. 3. In order for the scenario to work, the payment difference MUST be invested and not spent.

With that said, I am making available the spreadsheet I used for this post, which you can download here: Mortgage Amortization Comparison (Two 15-year Mortgages). I didn’t spend a lot of time making it user-friendly but if you understand the basics of Excel, you can get in there and change up the variables yourself.