I’ve been quietly watching different outlets discuss the possibility that the 30 year mortgage might just be out of touch with 21st century reality: People just don’t stay in their homes for 30 years anymore thus making this American dream a nightmare for many.
|Aside: This is a long post and I rarely write articles this long, but I promise, the information presented is worth it |
Arkadi Kuhlmann, CEO of ING wrote a well thought out piece in the Washington Post Op-Ed and I think lawmakers should take note:
More than nine out of 10 U.S. homeowners have long-term, fixed-rate loans. But the 30-year fixed-rate loan is dangerously outdated. It was created in the late 1940s, when the economy was fundamentally different. Just as fewer Americans remain with one company over their careers, fewer Americans remain in one home over their working lives.
And while a locked-in interest rate can provide peace of mind, consumers pay for that stability in front-loaded interest costs, slow buildup of equity and the many fees associated with refinancing or remortgaging. Last week, according to the Mortgage Bankers Association, refinances accounted for nearly 83 percent of mortgage applications.
If Congress is going to play a role in the housing market, it should create an incentive for consumers to pay down their principal home cost more quickly and accumulate equity. The tax deduction for mortgage interest payments encourages Americans to purchase homes, but the break comes on the wrong part of the loan — the interest, not the principal.
This tax credit could work well for consumers and banks. Shorter-term, fixed-rate loans generally carry lower risks for banks than 30-year loans do, resulting in lower interest rates. On a typical $225,000 mortgage, a buyer who gets a five-year, fixed-rate mortgage at 3.50 percent might well pay 4.75 percent for a 30-year loan. The savings would come to more than $11,000 when it’s time to refinance the five-year agreement.
The savings generated from shorter-term loans could be put directly toward paying down the principal by consumers eager to build equity. Instead of chipping away at their mortgage over half a lifetime, people would achieve the security that comes from homeownership much faster — and our nation would be encouraging savings, not debt. And anyone worried about a potential rise in interest rates could simply refinance at a different point or for a slightly longer period.
It’s time for change. I think he brings solid ideas to the table that should be considered, but our political system makes it hard to bring about that needed change. Looking to Canada’s system for inspiration once can see that it does indeed work while meeting the needs of homepotential homebuyers.
1. Full Recourse Mortgages in Canada. Almost all Canadian mortgages are “full recourse” loans, meaning that the borrower remains fully responsible for the mortgage even in the case of foreclosure. If a bank in Canada forecloses on a home with negative equity, it can file a deficiency judgment against the borrower, which allows it to attach the borrower’s other assets and even take legal action to garnish the borrower’s future wages. In the United States, we have a mix of recourse and non-recourse laws that vary by state, but even in recourse states, the use of deficiency judgments to attach assets and garnish wages is infrequent. The full recourse feature of Canadian mortgages results in more responsible borrowing, fewer delinquencies, and significantly fewer foreclosures than in the United States.
The full recourse feature of Canadian mortgages results in more responsible borrowing, fewer delinquencies, and significantly fewer foreclosures than in the United States.
2. Shorter-Term Fixed Rates in Canada. Canadian mortgages carry a fixed interest rate for a maximum of five years, and rates are then re-negotiated for the next five years, similar to a five-year adjustable rate. This practice allows banks to achieve a better maturity match between their assets (mortgages and loans) and interest income, and their liabilities (deposits) and interest expense, which protects them from the kind of maturity mismatch and interest rate risk that resulted in our S&L crisis and almost 3,000 bank failures in the 1980s and 1990s.
3. Mortgage Insurance Is More Common in Canada than in the United States. About half of Canadian mortgages carry mortgage insurance (compared to 30 percent in the U.S. currently and only 15 percent before the crisis), primarily for those mortgages financing the purchase of a home with less than a 20 percent down payment, and the borrower is required to pay the full mortgage insurance premium upfront. Another difference from the U.S. is that when private insurance companies in Canada insure mortgages, they have the authority to approve or reject the property appraisal, and they have strong financial incentives to only approve realistic property appraisals. Mortgage insurance in Canada covers the full loan amount for the full life of the mortgage, and cannot be eliminated like in the United States when the property value exceeds the mortgage balance. The traditionally much higher frequency of mortgage insurance in Canada compared to the United States helps to stabilize Canada’s mortgage and housing markets, and is one of the many features that contribute to its ranking as the safest banking system in the world.
Compared to the United States, the Canadian banking system is much more concentrated, with the five largest Canadian banks (out of only 82 in the entire country, compared to more than 8,000 banks in the U.S.) holding more than 80 percent of total bank assets.
4. No Tax Deductibility of Mortgage Interest in Canada. Home mortgage interest has never been tax-deductible in Canada, so there is no tax advantage to home ownership in Canada over renting. (Addendum: Except that any capital gains from the sale of a principal residence in Canada are not taxed). There is also no tax benefit to converting home equity into household debt in Canada, which has resulted in a much greater equity accumulation in Canada (70 percent of total real estate value) than in the United States (currently only about 45 percent). Also, paying down your mortgage in Canada is a tax-free investment and further encourages greater equity accumulation than in the United States. Interestingly, even without any tax advantage for home ownership, the Canadian homeownership rate (69 percent) is actually higher than in the United States (67.2 percent).
5. Higher Prepayment Penalties in Canada. Prepaying mortgages in Canada is allowed, but there are much stiffer prepayment penalties (three months of mortgage interest) than in the United States, which discourages the kind of refinancing that frequently took place in the United States leading up to the housing meltdown, and often involved pulling home equity out in the refinancing process (encouraged by the tax deductibility of mortgage interest).
Home mortgage interest has never been tax-deductible in Canada.
6. Public Policy Differences for Low-Income Housing. To promote affordable housing for low-income households, the Canadian government has not used public policies like the Community Reinvestment Act in the United States, which encouraged homeownership for lower-income and less creditworthy borrowers, financed frequently with subprime mortgages. Instead, the Canadian government provides public funding for low-income rental housing, rather than encouraging homeownership for low-income households, and Canada has thus avoided the American mistake of using misguided policies to turn good, low-income renters into bad homeowners.
7. Differences in Canada’s Bank Concentration and Greater Diversification. Compared to the United States, the Canadian banking system is much more concentrated, with the five largest Canadian banks (out of only 82 in the entire country, compared to more than 8,000 banks in the United States) holding more than 80 percent of total bank assets. This concentration became an advantage during the recent financial crisis because it facilitated critical discussions among the five large banks and the single federal regulator (the Office of the Superintendent of Financial Institutions). Also, Canada has never had branching restrictions like the U.S. laws that prevented interstate banking up until 1994, and this has historically allowed Canadian banks to achieve geographical diversification for their deposits and loans portfolios. It was largely this difference in geographical diversification that help explains why the United States had 9,000 bank failures during the Great Depression (each operating within only one of the 48 states, due to the prohibition on interstate branching) and not a single Canadian bank (all with branches nationwide) failed in the 1930s.
Interestingly, even without any tax advantage for home ownership, the Canadian homeownership rate (69 percent) is actually higher than in the U.S. (67.2 percent).
8. A Few Other Differences that Contribute to Bank Safety in Canada. There is a much lower rate of loan originations by mortgage brokers in Canada (only 35 percent) than in the U.S. (70 percent), far less mortgage securitization in Canada than here, and a much smaller subprime mortgage market. Banks in Canada keep and service 68 percent of the mortgages on their own balance sheets that they originate and underwrite, which encourages prudent lending since banks are putting much of their own capital at risk. Finally, almost all mortgage payments in Canada are made electronically by an automatic payment arrangement, which minimizes late payments.
Bottom Line: Taken together, the features and regulations of banks in Canada outlined above create a healthy and sound “pro-lender” environment absent of political motivations for outcomes like greater homeownership, compared to the often politically motivated “pro-borrower” and “pro-homeowner” policies of the United States. While Canada’s banking system has promoted responsible borrowing and prudent lending and underwriting practices with little politically motivated interference, the U.S. banking system seems to have encouraged excessive lending to risky borrowers because of the political obsession with homeownership.
Keep in mind that while I agree with most of the above-mentioned, I don’t agree with all of it. There should be no pre-payment penalty if you want to move or have to for work, divorce or other reasons. People shouldn’t be tied down to a mortgage resulting in a penalty if they want to leave.
Introducing the morlease.
Since no one really buys homes with the intent to stay in it for 30 years ….
About 40 million people move annually in the US. Nearly 3/4 of the US population moves an average of once every 5 years. Many things contribute to these statistics:
– shifts in the economy; for instance, from the Rust Belt to Silicon Valley.
– the doubling of the divorce rate in last 30 years; divorce results in many moves, and sometimes moves can trigger divorces!
– corporate transfers play a role
– changes in status (i.e., marriage, graduation from college, retirement, etc.) are common reasons for moving.
Why not create a hybrid mortgage-lease with some benefits remaining (equity, tax benefits etc, the longer you stay the more you get) and at the end of the term then you renew OR leave.
I haven’t done the numbers on how that would work when you’re selling to someone else or if the bank is stuck with it until it is sold but it’s an idea worth discussing since the way things are right now isn’t working.
People are moving for new jobs, to be closer to family, military transfers, divorce etc and can’t because their credit will plummet if they aren’t able to manage two payments or rent it out with enough cash flow cover the mortgage.
So requiring someone to stick out a 30 year mortgage nowadays just doesn’t make sense anymore. The goal wouldn’t be to pay off the home in 5 years but to stay in it for at least 5-7-10 years and then have the option of leaving. If you plan to stay in it for over 10 years then you can get the standard 15-20-30 year mortgage or go with the above mentioned plan by Arkadi Kuhlmann.
This way there would be at least 3 options for those wanting to buy a home. And yes, that means I am throwing in my thoughts on mortgage changes into the ring.
What are your thoughts on this blossoming debate? Is the 30 year mortgage outdated? Why? Why Not?