Regardless of what the guy does, he’s in deep doo doo. He paid $340,000 (financing $272,000) for a house that is now worth between $120,000 and $140,000. He can afford the payment but is still thinking about walking away since the purchase is no longer in his favor. I wish I had more details regarding his situation but I don’t. That one advisor who talks about the after-tax cost of the mortgage makes some sense in that the true cost of the mortgage is less than this guy thinks it is.

Still, using a current value for the house of $140,000, at a 3% appreciation rate, it would take 30 years for the house to appreciate back to the purchase price. An appreciation rate of 5% would take 18 years. Bottom line: this guy’s going to be underwater for a long time.

In the comparison above the amount in savings is only listed for the 30 year mortgage. Where does this number come from? Multiplying $458 times 180 (months) come to $82440. Nonetheless, one really important peice is missing. If I am in the 15 year category, and I just paid off my last payment of $1696. How’s about I save $1696/mo for 15 years and then let’s compare savings accounts. At the end of 15 years of saving $1696 (as I paid off my mortgge after 15 years), my savings account reads a sweet $305,280. Did I miss something?

His comment refers to this graphic:

Let’s look at this reader’s questions, one at a time:

In the comparison above the amount in savings is only listed for the 30 year mortgage. Where does this number come from? Multiplying $458 times 180 (months) come to $82440.

The savings is the difference in payment amounts between the 30-year and 15-year mortgages. I went on the assumption that the person could afford either mortgage and that the payment difference would be saved and invested.

Simply multiplying $458 by 180 ignores the potential investment growth. In the example, I used an 8% growth rate. Granted that rate has turned out to be high given the bad markets we have had recently. But the 8% number is well within reach over the long-term.

The reader then goes on to say…

Nonetheless, one really important peice is missing. If I am in the 15 year category, and I just paid off my last payment of $1696. How’s about I save $1696/mo for 15 years and then let’s compare savings accounts. At the end of 15 years of saving $1696 (as I paid off my mortgge after 15 years), my savings account reads a sweet $305,280. Did I miss something?

Yes, he missed something. If you look at the graphic, you’ll see that I do in fact assume that after the 15-year mortgage is paid off the payment ($1,696) is invested at an 8% rate of return for the next 15 years. That’s why the savings account balance at the end of 30 years is $587.009 rather than the $305,280 that the commenter mentions ($1,696 x 180 months).

Anyway, I won’t go into all the details of that post. You can read it here along with all the very thoughtful comments that followed.

I took the information found in that chart and made another graphic showing just how much interest a person would pay over a 30-year mortgage depending on their credit score:

As you can see, the difference is significant. Just moving from the second highest to the highest FICO Score ranges saves you nearly $10,000 in interest over 30 years (even more if you factor in growth on the $27 per month payment difference). The difference from the lowest to the highest ranges, is nearly $100,000 in interest expense over 30 years (or nearly $200 per month)!

My advice to anyone looking to finance a purchase is to first GET A HANDLE ON YOUR FICO SCORE! The $16 spent to find out your score is an investment—especially if you have no idea what your FICO score is. The information provided to you by myFICO is easy to understand. They also show you areas that are hurting your score and things you can do to improve it.

Then take the time and effort to improve your score. Remember the two most important areas of your FICO score are:

• How timely you are with your payments, and

• How much you owe compared with your total available credit.

I would keep those in mind, along with the other items that go into calculating your credit score (found here) if a major purchase in your future.

Related:

My FICO Score is 794. What’s Your Credit Score?

The 2009 Personal Finance How-to Roundup

Bureaus Roll Out New Credit Score Formula for 2009

How Long Will It Take to Improve a FICO Score?

I wanted to point out one of the stories in the article:

Insurance adjustor Ginger Shields says she tried for years to qualify for a home loan. After a decade and a half of renting, she and her husband sought a loan in 2003 from a TD Banknorth office in her north-central Vermont town of Barre. The bank’s loan officer said their credit score of 550 — below the level considered healthy — wouldn’t allow them to qualify.

A local mortgage broker said the same thing, recalls Ms. Shields, now 59 years old. The couple had no savings, and were saddled with credit-card and other debts. They had liabilities she says they didn’t know about, including debt on a totaled car they thought the insurance company had paid off.

TD Banknorth wouldn’t discuss the specifics of Ms. Shields’s application. But the rejection of someone who can’t show their ability to repay a mortgage “is more common than not in the state of Vermont,” said Stephen Kaminski, a senior vice president of mortgage products.

Ms. Shields and her husband went to a nonprofit mortgage-assistance program, NeighborWorks. There, a counselor guided them through paying down their debt and fixing their credit report. They were frustrated at missing out on houses they liked and tempted by mortgages they saw advertised on TV and the Internet, but heeded their counselor’s advice to hold out for a loan they could afford.

Eventually they raised their credit score to 670, says their counselor, Harry Sanderson. In 2006, he helped the couple buy a three-bedroom, ranch-style house on a quarter-acre lot, through a Department of Agriculture program that offers mortgages to lower-income households in rural areas.

Ms. Shields’s husband died last year. She continues to meet her monthly payments. “With my husband gone, I really think I would not have been able to keep the house” under earlier loans they had considered, she said.

I understand this woman’s frustration but surely she has to understand that her decisions in the past put her in the situation where she couldn’t afford to buy a house. My wife and I were in the same boat. Fortunately, we bought a house we could afford and we worked our butts off, paying down our credit card debt. We lived in an unremodeled house for 8 years before we had the money to make improvements.

The article also mentions that Vermont missed out on the housing boom because of their standards. My question is what good is a ‘boom’ if the underlying economics aren’t there to support the boom? I think what we saw with the internet boom and then with the housing boom, was the errosion of standards, which leads to unsustainable booms.

One last thing I want to mention about this article is that Vermont made mortgage broker’s a fiduciary for the borrowers and not the lenders. This was huge.

I know not everyone can do this but you have to applaud the effort of this woman.

So…

Today I want to look at mortgage interest. You may have seen this graphic before:

This graphic shows the point at which the percentage of a mortgage payment going to principal is equal to percentage going towards mortgage interest. This example is based on a 5.5% 30-year fixed rate $200,000 mortgage.

It’s interesting to note that on a 360-month loan, the percentage of the payment going towards principal does not exceed the percentage going towards interest until payment #210 (about 17.5 years into the loan). At payment #210, you will have paid nearly 76% of the total interest due on the loan, as shown in the following graphic:

This graphic shows that at the end of 10 years, you would be 33.33% of the way through paying off your mortgage, but would have already paid 48.54% of the total interest on the mortgage ($101,351 total interest paid ÷ $208,808 total interest on the loan). The difference (or spread) between the two numbers is -15.20% (33.33% – 48.54%). The spread continues to widen until payment #202 and begins to narrow at payment #207 as the following graphic shows:

BOTTOM LINE

All of this is just another way of showing how interest on loans is front-loaded (81% of the first payment goes to pay interest). You can use this to your advantage by paying more towards your principal at the beginning of the loan rather than waiting until the end of the loan—that is if it is your goal to pay off your mortgage as quickly as possible.

Thoughts?

NEW YORK, July 14 (Reuters) – U.S. government officials are weighing a plan that would let borrowers who have fallen behind on their mortgage payments avoid eviction by renting their homes instead, sources familiar with the administration’s thinking said on Tuesday.

Under one idea being discussed, delinquent homeowners would surrender ownership of their homes but would continue to live in the property for several years, the sources told Reuters.

Officials are also considering whether the government should make mortgage payments on behalf of borrowers who cannot keep up with their home loans, tapping an unused portion of a $50 billion housing aid kitty.

As part of this plan, jobless borrowers might receive a housing stipend along with regular unemployment benefits, the sources said. (Reporting by Patrick Rucker; Editing by Diane Craft)

This is taking government housing to a whole new level. It also raises a whole bunch of questions:

• What would be the implications of such a plan?

• Does the government continue to pay the mortgage?

• What happens after several years of the former homeowner paying rent? Do they get to buy the house back? For what price?

• What if they can’t afford the rent?

• Where does it end?

Here’s the deal:

Overstating your income (lying) on a loan constitutes fraud. Fraud is punishable by law.

I haven’t found any hard numbers on how many stated income loans were used or how many of the stated income loans were overstated. But, it shouldn’t have been that hard to figure out. If you say you make $16,000 a month and in reality only make $3,600 per month (an example in the book), it wouldn’t take long for that overstatement to come to light. All one would have to do is find the paperwork and then compare that to tax returns. And, this could be done by those who are helping people stay in their homes.

Unfortunately, prosecuting the fraudsters would most likely be an expensive process.

I’m not against helping those who LEGITIMATELY need help. I just don’t like the idea of helping those who might have committed fraud.

Just think, this entire crisis probably could have been averted had lenders insisted on income verification!

As my regular readers know, I have blogged a lot about the subprime mortgage crisis. In one of my posts, I mentioned that brokers were incentivized to put prime borrowers into subprime products. One of my commenters (mortgage broker I believe) argued that brokers were not given incentives to promote one type of mortgage over another. Well, unless David Faber is lying, on page 71 he writes that some brokers WERE given incentives (emphasis mine):

The higher the rate on the mortgage, the more money the originator would be paid in that rebate** by Wall Street. “If you could sell the loan for a highter rate and sell a lot of them at a higher rate, the Wall Street was in love with you. They would bend over backwards for you. They would buy anything you’d give ‘em, just about,” gushed [Lou] Pacific. Subprime loans carried a low initial rate, but over the life of the loan a very high rate. It proved to be the perfect product for Wall Street. It also proved tempting for many of the subprime firms to convince consumers to take a subprime loan even if they qualified for a much lower-priced prime loan. “We used to get an awful lot of them [prime borrowers],” say Pacific unapologetically. “They were more concerned with the pseed of getting a loan. And plust the average person doesn’t understand where their credit ranking is, some don’t think they can qualify for a good loan, but they can. So0 they’ll call and if you sell a loan with a higher FICO score, you’re going to make more money on it.” Pacific claims that when he encountered such a person he would refuse his business and tell him to go to his local bank.

Yeah, right. I’m sure Mr. Pacific turned the business away. He may have, I don’t know. Let’s just say I’m skeptical.

Of course, the AFM commenter may not have been given incentives if he worked for a smaller firm that didn’t have a direct relationship with Wall Street. I suppose that is possible.

I encourage you to pick up a copy of David Faber’s And Then the Roof Caved In*. It’s a page-turner as David does an excellent job of explaining the story in a way that most people can understand it. I’ll be mentioning more tidbits from the book in the near future.

*Affilitate Link
**Also known as a yield spread premium.

Re-read the commenter’s first sentence and you’ll see what I mean:

Two years ago we stopped investing in our 401k and we began paying thousands against the principal on our home.

The money they put into their 401(k) was pre-tax. If they were maxing out their 401(k) at $15,000 per year and were in the 28% tax bracket, they were saving approximately $4,200 in taxes. When they stopped contributing that $15,000, they had to give $4,200 of it to the government. Yes, the market was horrible last year and they probably made some money on their gamble. But, long-term it probably hurt them from a purely financial standpoint.

They made a decision based on emotion. It’s funny to me how we always talk about keeping our emotions in check and then we applaud an emotional decision such as this.

If this couple had extra money that they wanted to put towards their mortgage, I could see that. But forgoing their 401(k)? That just doesn’t make sense to me.

Thoughts?