Jun222013

Cheap credit and low cash returns causing mortgage debt bifurcation

One of the side affects of Quantitative Easing (QE) and the Zero Interest Rate Policy (ZIRP) has been ability of homeowners with debt to refinance at lower rates with shorter mortgage terms like a 10 year, 15 year or 20 year fixed rate mortgages.   Even the loan mods for loanowners have cheap teaser mortgages rates.  The result of this side side is homeowners are being dividend up into loosely dividend groups.  1) loanowers that will have no equity on their homes after 10 years. 2) Homeowners that have refinanced into 10, 15, or 20 year mortgages that nearly paid them off after 10 years.  This have implications for retirement for these two different groups of indebted  homeowners.

The other key factor related to interest rates and mortgage rates is that Certificates of Deposits are paying yields of less than 1%.  This low yield is encouraging borrowers that are debt adverse to lock in these much shorter loan terms. What is the alternative investment for your savings, depositing your money into the bank with such a low yield?  These are Seniors looking for cash flow to pay bills.

Pre-retirees help fuel surge in low-interest, 10-year mortgages

By Kenneth R. Harney,

The refinancing boom may be cooling down, but the move to shorter mortgages — especially 10-year loans among pre-retirees — appears to be accelerating.

Some community banks say 10-year mortgages, once an insignificant niche option, are now accounting for increasingly large chunks of their business. For example, Rockville Bank in South Windsor, Conn., reports that 10-year loans represented a surprising one-fifth of its total residential mortgage originations in dollar terms last year.

Also, in a survey released last week, Freddie Mac, the giant federal mortgage investor, found that 28 percent of all refinancings in the first quarter of 2013 involved shortening of terms. Among refinancers with 30-year mortgages, nearly one-third switched to shorter-term replacement loans.

Though 15-year mortgages have been popular for years among homeowners who want to pay off their balances quickly, lenders say the 10-year loan — targeted directly at the demographic tsunami of baby boomers who are still employed but planning to retire in the coming decade — is on the upswing.

You need a lot more than free and clear house to retire, you also need savings and income.  Interesting enough early withdrawals from retirement savings is that all time high.  Hopefully, these people getting these 10 year fixed rate mortgages are saving more and not just asset shifting.

“There’s a lot of interest in this [10-year] product,” said Victoria Stumpf, a loan officer with Third Federal Savings and Loan in Cleveland.

Why the growing attraction to going short? Start with interest rates. With an almost-certain increase in rates on the horizon as the Federal Reserve begins to taper its purchases of mortgage bonds and Treasury securities, fixed rates on 10-year loans remain enticingly low. According to MyBankTracker.com, which surveys 7,000 lenders nationwide on rates and terms, the average 10-year fixed-rate mortgage goes for 3 percent with a fifth of a point. (A point equals 1 percent of the loan amount.)

But many community banks and smaller lenders quote much lower than that. Rockville Bank’s current rate for a 10-year — whether for refinancing or a home purchase — is 2.375 percent with no points. Third Federal’s quote for a $200,000 10-year mortgage is 2.79 percent with a closing fee of $450. For community lending institutions such as these around the country, 10-year loans tend to be portfolio investments. Rather than selling the mortgages to Freddie Mac, Fannie Mae or other investors, lenders retain them in-house. Partially as a result, rates can be lower. And since lenders that specialize in 10-year mortgages want to keep risks as low as possible on their in-house investments, they typically require borrowers to have solid credit histories and significant equity or down payments.

Ironically, before Fannie and Freddie came along, most banks lent residential loans on much shorter terms (5 or 10 years) usually with a balloon payment.  It was much less riskier loan for a bank than a 30-year fixed rate mortgage.  This current 10 year loan product is closer to pre-GSE terms and rates which is why bank are probably retaining these products.

Picture this: You’re in your prime pre-retiree years — anywhere from the mid-50s to early 60s. You’ve got a good income, significant equity in your home and good credit scores, and you want to refinance to a lower rate. Your home is worth $250,000 and you need a $150,000 loan that will leave you mortgage-debt-free — or close to it — once you’re into retirement. You don’t want to risk potential interest-rate spikes along the way, so adjustable-rate loans are out of the question.

How does a 10-year loan stack up? Consider this comparative scenario using current rates and terms for 30-year, 15-year and 10-year loans provided by Jeff Lipes, vice president for mortgages at Rockville Bank:

●Interest rates: The 10-year’s 2.375 percent rate is the lowest by far. The rate on the 30-year fixed is 3.99 percent; on a 15-year, it is 3.25 percent.

●Monthly payments. Here’s where the shorter term and faster payoff of principal available through the 10-year mortgage can be a budget issue for some borrowers. The monthly total for principal and interest on the 30-year loan is just $715. On the 15-year, it’s $1,054. But on the 10-year, it’s nearly double what you’d pay on the 30-year: $1,406. Though over the term of the loan you pay substantially less in total interest charges, on a monthly basis the 10-year requires the most out of pocket of the three.

Frank Nothaft, chief economist for Freddie Mac, says that as part of a retirement planning process designed to leave you with lower debts at a predetermined point, a 10-year mortgage “could be an ideal product,” provided you’ve got the resources to handle the higher monthly payments. Ditto for a 15-year loan.

Bottom line: If you’re looking ahead, want to lock in what may be once-in-a-lifetime low rates and like the idea of getting rid of all home-loan debt for your retirement years, check out the mortgage-shortening trend. A 10-year just might be a fit.

The affect is that low mortgage rates and the horrible Certificate of Deposit returns is dividing mortgage debtors into two groups; those that want to pay off their loans and those that will never have equity (ie. the debt serfs).  If mortgages conditions remain the same of over a long period of time you have an lower home ownership rate.  Also, you have a larger percent people that will own multiple homes for rental income because it now has partly replaced fixed income formerly earned in a bank.  Rental income is replacing the old fashion “money in the bank” mentality. And paying off your debt is the new way retain your purchasing power in era when incomes are falling.   I prefer the times you could put money in the bank instead of what we have now.

Now, will these trends continue for a long time?  You have the federal government that is deeply in debt and must keep interest rates low, so the interest payment doesn’t cause a sovereign debt crisis.  You also have a banking sector that’s has potentially over $1 trillion in bad, which has interest keeping mortgage rates down.   Maybe in 10 plus years we might have the pre-2007 system where banks use to pay you a decent rates of return.  However, I think for the remainder of the decade you will have ZIRP and hopefully QE will disappear next year.

Do you want to be free and clear home owner or a debt serf?  It’s sort of what is happening.

Mike

PS I wrote this before I went on vacation this week and before the spike in mortgage rates.  If these rates remain the same or move higher over the next few months, it might be the end of the great refinance period and the end of homeowners refinancing into this 10-year loan product.  These mortgages rates will also impact the number of loanowners that underwater.  These numbers have been falling only because house prices have been increasing.