Rumors are circling that the FHA will implement a new, ultra-low interest rate refinancing program to help cash-strapped borrowers. This plan has an unintended consequence that would devastate the housing market for years to come.
Borrowers will have a HUGE incentive NOT to move in the future. It’s as if the government was going to pay a portion of your mortgage in return for you NOT moving for a decade or two. This is insane.
Simple Math
For example, let’s assume a $200,000 home with 20% down and a loan of $160,000. Now, let’s assume a 3.5% interest rate (about 1% below today’s rates).
The borrower would have principal and interest payments of $718.
Fast forward 5 years.
Pretend that homeowner wants to move to a different house that costs $200,000. Let’s again assume 20% down.
At a reasonable 6% interest rate, the borrower would pay $959 a month. That’s an extra $241 each month in interest!
Unless they are absolutely forced to, these homeowners simply will not move.
Here in the Bay Area, let’s use an example of a $500,000 mortgage on a $500,000 house (it is FHA, after all ).
At 3.5%, that’s principal and interest of $2,245 per month.
Five years later, if they wanted to buy another $500,000 house at 6%, the payments would jump to $2,997.
To achieve a similar payment to what they had, the purchase price on the new house would have to drop to about $375,000.
They are trapped in their homes unless they choose to accept a big downgrade for the same expense!
Market Stagnation
As a result of this ultra-low-interest refi program, more people will choose not to move. This immobility hurts job productivity and flexibility. Low housing turnover makes markets less liquid, hurting everyone. And, even worse than the tax credits, we could see years of mortgage refi demand pulled forward. Fine now…but then what?
Proponents would argue that a refi boom would spark economic activity today. But, once that temporary boost is realized, we’ve got even less economic spark to look forward to in the future.
Just like everything else that’s happened over the last 2-3 years, The Powers That Be are trying to kick the can a little further down the road.
And, that poor borrower is stuck with $500,000 in debt instead of $375,000.
August 4, 2010 at 9:23 am
Yeah. This plan sounds like a great way to really mess up future economics. A subsidized interest rate now would greatly reduce future jobs for not only mortgage lenders, but real estate agents, title companies, home inspectors, home warranty companies and more.
And in you’re examples you have a modest interest rate of 6%. Chances are that as the economy starts to actually recover we’ll see some serious inflation, which would mean interest rates much higher than 6%. The average mortgage interest rate over the last 50 years is something closer to 9%. That will really decrease incentive for people to ever move if they didn’t absolutely have to.
August 4, 2010 at 1:49 pm
It certainly would be rough for those of us who make a living off of real estate transactions.
August 4, 2010 at 11:37 pm
You guys who make a living off of buying and selling houses would take a huge hit. Average people would benefit. Wow, what a concept!
August 5, 2010 at 2:57 am
Good micro economic observation. But here’s an even larger problem. If there’s massive prepayment of the BETTER loans in FNMA, FRE and conventional mortgage backed securities, what’s left in the MBS pools? The VERY BAD loans. Securities owners get paid out the prepayments, but what’s left is pure loss. Jim
August 5, 2010 at 5:56 am
Author fails to consider price fluctuation as interest rates rise and fall. Author assumes that 200K buys the same house whether interest rates are 3.5% or 6% and applies “simple math” realtor style.
Author concludes that people will just opt to “not move” which is a ridiculous conclusion pulled from thin air rather than the result of any evidence.
Author concludes that market stagnation is caused by interest rates and not by overpriced houses.
Author did successfully argue that houses priced at 500K have a six figure haircut coming and that realtors are going to lose money.
World’s smallest violin right here – can you hear it? I hope so.
August 5, 2010 at 6:13 am
Can you imagine the horror to be when all these folks who are mortgaged to the hilt on 30 year payment plans opt to stay in their houses after 5 years rather than buy another house? GASP!!!!!!
August 5, 2010 at 6:23 am
1. The is a REFI program, not for homebuying. So, yes, the costs of refinancing vs buying new ARE very different.
2. Correct, people will have more incentive not to move. Therefore, statistically, a percentage won’t. That’s a perfectly sound and logical conclusion.
3. Here, market stagnation WOULD be caused by crazy-low refi rates because people would be incentivized not to move. No turnover = stagnation.
I think you missed the point that this is rumored to be a refinancing program only, with the ultra-low rates not available to regular buyers.
Author would like to see Gov’t manipulation end so home prices can find a natural, organic bottom. Only then can the housing market and economy look forward to any kind of recovery.
August 5, 2010 at 6:25 am
It’s even worse than the author says. Not only would the monthly payment rise $700/mo. for the new house, the old house would sell for $125k less than the seller paid. The combination of the two would effectively lock in a long-term downward trend in housing prices worse than the already horrible long-term downward trend we are looking at today. This should be known as the realtor unemployment act.
August 5, 2010 at 6:38 am
We do not want times to be hard for realtors. I am writing to my congressman today to see if something can be done to help you guys out. I have a couple of ideas:
1) We tax renters to subsidize some kind of mortgage interest deduction for house debtors. This will give the masses more incentive to partake in a real estate transaction.
2) We tax renters to subsidize some kind of house purchase tax credit for house buyers. Again, another incentive to get those renters to stop being so stubborn and partake in a real estate transaction.
3) We create some kind of Government Sponsored Enterprise to run a Ponzi Scheme that purchases mortgages from banks and sells them to investors in order to make sure that buyers don’t need down payments and house prices get nice and inflated so that used house peddlers can make some extra money on each deal.
4) We create a secret database that only realtors can access and require that all house buyers must use in order to find houses that are for sale. Sellers who try to sell on their own will be blacklisted and get no traffic. This will force all house buyers to retain a realtor for their purchase.
5) We launch a two pronged propaganda campaign on the nation’s radio and television media with commercials that glorify real estate “ownership” and the “American Dream”. We may also consider dedicating some channels to strictly airing real estate programs that groom future buyers by associating an entertainment product with real estate transactions.
6) We organize a group of lobbyists to represent realtors in Washington DC and ensure that unfavorable legislation that impacts realtor income is fought tooth and nail to ensure that buyers overpay by as much as possible on their real estate transactions.
Those are just a few of my ideas to help realtors out of tough times. If anyone has any more, please let us know. We need to act soon! Thank you.
August 5, 2010 at 6:54 am
Why would a house buyer have less incentive to move if they can buy a similar house with the same payment? You are failing to acknowledge that when interest rates go up, house prices go down. Your analysis assumes that buyers are locked into their houses because they will not find a similar house for the same monthly payment which is not true. The real reason that many of these people are not going to “move” is because of the negative equity situation that they find themselves in as house prices continue to fall. They will be trapped under all that debt – not because of comparable monthly payments.
August 5, 2010 at 7:07 am
What is most ironic is that the author (a realtor) is advocating that the government remove itself from the equation. He does not appear to get it – that the Government is the only friend that his industry has left. If Big Brother stopped greasing the wheels with al of the sucker gimmicks, our author would most likely be out of business for good as the entire market is now supported by the Government’s anti-Capitalist intervention in favor of Socialism that benefits a few. Continued Government carrot-dangling is all the author has left to hope for at this point. The good news is that he has friends in high places making sure that houses stay unaffordable and also making sure that wealth is transferred from renters to house debtors.
August 5, 2010 at 7:25 am
“He does not appear to get it – that the Government is the only friend that his industry has left.”
No Dave. I completely get it. Just because I am a real estate agent doesn’t mean that I am a cheerleader for all-things NAR.
The Government’s pro-homeowner agenda and decades of subsidizing homeownership helped create the bubble and now draw out the pain. Efforts to make homeownership more achievable have only resulted in higher prices. My preference as a citizen is to see these programs and this agenda come to an end.
My industry doesn’t need friends to survive. Regardless of prices, interest rates, or homeownership rates, people will still buy and sell property. And, a good percentage of those people will be willing to pay for professional help.
August 5, 2010 at 8:04 am
First of all, the phrase “Pro Homeowner” is debatable. If we are defining Homeownership as property that is owned “free and clear of any such mortgage lein” then we can conclude that the present state of affairs is not line with the stated agenda. However, if we try to describe it as “Pro House Debtorship” or “Pro Unaffordable Housing” then that better describes the current state of affairs. I think it is disengenuous for you to use such a phrase as “Pro Homeowner”.
The Government has subsidized no such ownership. All subsidies require that the buyer obtain a mortgage product first (a pledge of indebtedness). The true ownership levels in this country are at historic lows – this fact is undeniable.
I am glad to see that you are advocating that the Government end all such support including mortgage interest deductions, tax credits, FHA, Mortgage backed Securities, etc. Unfortunately for you, this would be a disaster for your industry. I do not share your optimism that it can stand on it’s own otherwise your NAR would not be working so hard to keep the subsidies roling. Perhaps you should renounce your NAR membership – it would certainly get you more credibility in the blogosphere.
Agree that people will continue to buy and sell property with or without help but you do not address the volume of sales and prices that will be corrected as a result of this. You were despondent that a buyer might take out a 30 year mortgage and then not be able to move after year 5. Why is that so shocking? He is only 16% through his loan obligation at that point – he should be staying put.
August 5, 2010 at 8:17 am
“You were despondent that a buyer might take out a 30 year mortgage and then not be able to move after year 5. Why is that so shocking?
Because most people move every 6-8 years…up, down, left, or right. It could be for a new job opportunity. Or because they had another kid, or need to cut costs, or simply want a different environment. People make these moves to better their lives and these moves have a positive impact on the economy in numerous ways (besides RE commissions).
I am in favor of 30-year fixed mortgages. The problem here is that, in my opinion, this is a ploy by the government to keep people in debt.
Rather than sell, short sell, or walk away from their homes, borrowers are going to be suckered into keeping huge debts because the monthly payments would be low. It may help month-t0-month, but they still owe $500,000 in a declining real estate market. Many of these people will be screwed in the long-run.”
August 5, 2010 at 9:48 am
Greg,
Two years ago (Oct. 2008) a similar plan was proposed by the Dean of Columbia Business School. The Mayer/Hubbard plan was so absurd I began a blog intended to illustrate why Government intervention in the housing market would make the economic downturn worse.
The plan advocated reducing mortgage rates to 5.25% for homeowners and had no chance of working. Since then rates have fallen and persisted below 5.25% for 18 months to no productive end. Today rates are 4.5%. Anyone with home equity or good credit can access this record mortgage rate, but transactions are at Depression lows and prices are about to fall rapidly.
Manipulated, subsidized mortgage rates may only have the effect of extending and worsening the economic downturn. The only solution is sustainable market prices relative to undistorted economic conditions.
August 5, 2010 at 10:05 am
This is my exact situation.
Have a decent paying job, have enough down payment for 750k home, have good credit, also have a home bought in 2000, and after 4 refi’s, have a 4.5% 30yr fixed loan, with payment of 1100$. House probably worth 500k in Santa Clara, Ca.
Want to move up. But, I don’t see a reason to give up my current home and loan. Don’t want to take a chance with new more expensive home given the job market, 2 mortgages. Low interest reates are very appealing, but I would rather pay higher interest and pay less for the same home.
I kept running the numbers, but just couldn’t make sense to sell curent house, or remodel/expand. So just sitting on cash and keep adding more cash to the reserve. This doesn’t help the overall economy, but why should I take a chance? All along I have been living within my mean when most of the people around me were living large with easy credit, and honestly some of the co workes with PhD didn’t even know that their loans were negatively ammortised.
I really wish the government let the housing market correct itself. In the name of helping financially chalenged home owner, our tax $ are channel into bank’s balance sheet.
August 5, 2010 at 10:29 am
“why should I take a chance?”
With so much uncertainty surrounding housing, a lot of people will simple not participate.
There are two ways to encourage participation: 1) Bribe them with stimulus and gimmicks 2) Let home prices find a stable bottom so people know the worst is behind them.
August 5, 2010 at 10:36 am
Nice to see you here Whitney. Great site by the way. I’m a reader.
August 5, 2010 at 1:47 pm
Enough with “tax renters”.
Why should I pay for the mortgage of my neighbor? I want to buy a house too.
Just because I was responsible and didn’t buy an $800 000 house when it cost 300 000 just 6 years ago, doesn’t mean I have to sponsor those that did.
They promised to pay this amount – not me.
Just stop subsidizing and messing with housing prices and let prices settle once and get over it.
What is better:
- houses cost $1 000 000 and we all are in debt for life (no vacations, work-slaves, …)
- houses cost $100 000 and we pay it off in a few years and we can spend more time with family
Think about it…
August 8, 2010 at 9:57 am
I think AZDavid was being sarcastic as everything he mentioned already exists and that’s what is screwing up the housing market. His post is an excellent one!
July 28, 2011 at 9:59 am
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