Wednesday, December 17, 2008

Mortgage Question

I'll allow my massive ignorance to show for a moment here while I ask a question related to this mortgage crisis. Many people are upset, and rightfully so, that those with troubled mortgages may be given the opportunity to rewrite the terms of those mortgages. And I'm not sure whatever became of the idea, but during the run-up to the election even John McCain proposed that those with negative equity in their homes should be given the opportunity to reduce not only the amount they were paying in interest, but the principle owed on a home, in order to compensate for declining real estate values.

Throughout all this talk of monkeying around with mortgages, I never once heard it proposed that people with bad mortgages have their terms extended, so, for example, a 30-year obligation would be turned into a 40-year one. I'm pleading ignorance here, so I would love to know why this wouldn't be a good idea. Is the 30 year mortgage an industry standard or is it mandates by law? And in either case, why can't it be changed? It seems to me that it makes much more sense to hold individuals to their obligations, but adjust the terms by which they have to fulfill those obligations, rather than changing the nature of the obligations in the first place.


Anonymous rose said...

I'm responding 18 minutes after a post- looks like I'm stalking your blog.

I think the problem is a simple compounding/time value of money thing. If you're talking about 5% mortgage rates and therefore compounding at 5%, $1 today is worth more than $4 30 years from now. 40 years from now its worth about $7 (and 2% inflation takes 36years to double money). So you can extend the mortgage period by 10 years, but the money paid during that extra decade is severely discounted.

Also, the longer a loan, the higher the rate a bank demands, so you could be talking 7 or 8 bucks in extra costs down the road to save 1 today.

I don't really know for sure, I'm just guessing. It's an interesting idea though.

11:07 AM  
Anonymous rose said...

What I meant to say in conclusion is that discounting money paid in years 30-40 for 1) the time value of money and 2) the increasing risk of default the further out you go- probably means that an extra decade would have very very minimal effect on the size of monthly payments.

11:10 AM  
Blogger lonely libertarian said...

That's a very good point that really should have occurred to me.

But even so, it seems to me that there's got to be some way to adjust the terms of payment on these obligations as opposed to the total amount due. If someone can't afford to stay in their house at X cost per month, why not adjust that to an affordable rate for now while shifting the costlier payments to the back end. That way, people will have a more vested interest in making those larger payments.

Maybe in the end I'm arguing semantics here, but it seems to me that individual home buyers should bear the brunt of declining real estate prices. Having the government step in to fix home prices seems even worse than the sorts of things that got us into this mess in the first place.

1:40 PM  
Anonymous rose said...

Yeah, I see where you're coming from.

To play devil's advocate again though: if a person can't afford their mortgage today, it's dangerous to assume they could afford higher payments in the latter years of a backloaded mortgage. This after all is the same person who originated a mortgage that they couldn't afford.

So if you're the mortgage holder you run the risk of getting minimal payments for years, as that person continues to occupy the residence. When the payments scale up at some point in time and that person defaults you are fucked. You received minimal payments in a backloaded contract and are now foreclosing on a depreciated home. Wouldn't they have been better off foreclosing and selling at distressed prices in order to get that cash right away? I dunno. I assume these are the calculations mortgage professionals are experts at though.

I tend to agree w/ your first instinct. Stop all the government BS that creates impossible to predict environments for banks and mortgage holders and allow mortgage holders to make strategic self-interested decisions. I'd rather let banks/experts decide who to re-negotiate w/ and who to foreclose on rather than the feds.

Did you catch 60 minutes last sunday btw!? Too priceless. Had some woman who worked at a hair salon in her day job, who decided she was qualified to speculate on real estate. Used all of her savings to buy like five different properties using ARMs, with 20% down. Admitted to not understanding ARMs or reading the details of contracts and rationalized that that was ok because she, as a hair stylist, was very busy.


3:30 PM  

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