Challenging Group Think

By: Victor Normand

According to the Urban Dictionary, the expression “Do the math,” means to figure something out. To come to a solution or conclusion based on other facts. But my training, going back to my earliest experiences in the world of work literally means to do the math. Whenever I read an article with numbers in it, I do the math often discovering that something just doesn’t “add up” or that the verbiage doesn’t match the math. Or that the numbers have become group think detached from reality.

Tax Reform

The latest disconnect between the word on the street and the math has to do with tax reform. The group think within much of the housing community, including the National Association of REALTORS® has to do with changes to the mortgage interest deduction “eviscerating” the program and bringing home sales down and endangering the economy.

First of all, nothing yet has been turned into a bill let alone passed into law, so injecting panic into the marketplace is chilling and ill advised.

Secondly, even considering the most severe reduction from $1.0 million to $5 hundred thousand in mortgage debt, the reality is it will affect very few new homebuyers, mostly those buying big houses with big incomes. The average mortgage debt nationally is less than $225,000 and even in high cost markets, having a buyer’s tax liability rise by a few thousand dollars is not likely to be the go or no-go metric on a home purchase.

Down Payment Requirement

This still keeps coming up. Common knowledge among first time home buyers, reinforced by the printed word is that it takes 20% of the purchase price in cash to qualify for a mortgage. One of the Agents in the office asked a friend why she thought that way. Her response was that every time she went to her favorite real estate website and checked in with a mortgage calculator, the assumed number for down payment was 20%.

In actuality, according to the National Association of REALTORS®, about 60% of first-time homebuyers put down less than 6% on a home mortgage and in Massachusetts, there are programs that allow even less for qualified buyers.

Student Loan Debt

Seventy-five percent of all student loans are government loans and government loans provide for re-payment based on income which means that monthly payments are not necessarily tied to the amount of the loan but rather as low as 10% of the borrower’s income.

Lenders make loans in part based on debt to income ratios though it would be more accurate to say debt “service” to income ratios. From the lenders perspective, the amount of unsecured student loans a borrower has doesn’t matter but rather how much they pay each month on those loans.

Challenge everything; it’s a good practice and you will be surprised at how often the numbers don’t add up. It’s not a grand conspiracy; perhaps the media or word on the street picks up on a small or partial truth and runs with it because it seems to make sense and it very well may sometimes. Don’t be satisfied until you can relate the information to your personal circumstance. While the Resident Experts(sm) are not lenders or tax accountants, they know when you should be talking to one.

Student Loan (IBR) and Mortgage Qualification

Last month we discussed the very large problem of ever increasing student debt and its effects on first time home buyers. It’s clear that something needs to be done to bring higher education costs down and at the same time introduce some form of underwriting into the process of qualifying for a student loan. While there are differences between the sub-prime lending crisis and a student debt crisis, there are dangerous similarities as well.

In the meantime, there are many individuals and families who would otherwise be active in the housing marketplace but for the need to manage student debt. For good or bad, the debt is there and often perceived as an insurmountable barrier to home ownership. But there are options for those willing to seek them out.

For some, paying off college loans is paramount, and delaying home ownership and even marriage and starting a family will just have to wait. But the standard term of college loans, (10 years) is a long time to wait before the debt to income (DTI) ratios will be good enough to allow for a mortgage. Then there is the matter of a down payment and how that happens when there is no discretionary income.

The alternative for many with student debt is Income Based Repayment (IBR). This option is available to those with federal student loans, which is more than 75% of the $1.4 trillion in outstanding loans. These programs extend the repayment period for qualified borrowers to as long as 25 years. As you can imagine, the amount of interest paid under these programs relative to the original debt is substantial.

Qualifying for these programs involves calculating “discretionary income” which is the difference between adjusted gross income and 150% of the annual poverty line based on family size. Depending on when the loans were taken out, monthly payments are either 10% or 15% of that amount. A recent graduate with $60,000 of student debt who earns $40,000 annually could see their monthly payment decreased from $650 to as low as $180. There are many variables associated with IBR programs, but such decreases are not uncommon.

With discipline, someone taking advantage of an IBR could accumulate the cash needed for a down payment on a modest house or condominium. Making payments on time under an IBR program should reflect just as well on a credit score as payments under the original repayment plan. Loan underwriters and some of the Government Sponsored Enterprises (GSE’s) however do not look favorably on IBR plans.

Presently, some conventional lenders, FHA and USDA programs consider an IBR a temporary deferral and require underwriting to use the original loan terms or 1% of the loan balance, whichever is lower, to qualify a borrower. All IBR programs require annual re-certification, but they remain in place for as long as discretional income remains low and the borrower wants to participate. Fannie Mae and Freddie Mac will use IBR plans to meet their loan standards.

An added feature to some IBR programs is loan forgiveness. A graduate with high debt who is employed in a low paying profession, will have any balance remaining on their debt, forgiven at the end of the 20 or 25-year term. This may have tax consequences for the borrower, but it is something to consider. Of course, higher incomes than expected can always be used to pay down or pay off student loan debt at any time. And with home ownership, comes opportunities to use accumulated equity to pay down debt at lower rates of interest and greater tax deductibility options than student loan debt.

In conclusion, if those with student debt have a tolerance for making very high interest payments, especially during the early years of repayment, are willing to spend the time to learn more about the benefits and drawbacks of the IBR program and inclined to seek out a lender familiar with IBR, home ownership might just happen.

The Demise of the 30 Year Mortgage

By: Victor Normand
Published: April 2015

The subprime lending crisis is history, but its effects on the residential real estate industry will remain with us for a long time. The most apparent changes have been tighter lending standards and greater transparency with consumer protections for home buyers, but other less visible changes may be happening, changes that could make home buying out of reach for lower and moderate income borrowers looking for an affordable mortgage.

At the time of the crisis in 2008, the federal government through “government sponsored enterprises” (GSE’s) Fannie Mae and Freddie Mac, guaranteed more than three quarters of all outstanding home mortgages in the country. Though federally chartered for the public purpose of providing low interest rate mortgages and affordable housing, the GSE’s are privately owned by their stockholders, stockholders who were interested in profitability. To achieve increased profitability, the GSE’s fought increases in capital requirements and regulation.

When the financial crisis hit in September of 2008, Lehman Brothers filed for bankruptcy and the big banks were threatened with collapse, it would not be long before the GSE’s suffered the same fate. Nearly $200 billion was needed to keep them solvent. The U.S. Treasury provided the funds under the terms of a conservatorship that took control of Freddie and Fannie and set the stage for their eventual demise.

The view of many in the housing and banking industry is that without Freddie and Fannie there will no longer be the 30 year fixed rate mortgage that has fueled the home buying market.   At the end of World War II when only 40% of Americans owned their own homes, the 30 year mortgage envisioned as part of the New Deal in 1938 was new on the scene, today over 60% of Americans own their homes. Without the guarantees provided by the government through the GSEs, it is unlikely that lenders would be willing to take such long term risks, particularly in the current low interest rate environment. Today, many higher income home buyers are opting for 10 and 15 year mortgages, but the 30 year mortgage is critical to many first time and moderate income borrowers.

The structure of the conservatorship seems to dictate its demise, probably by 2018. Legislation in Congress has bi-partisan support and recently the President has indicated his support for a change. The effects of a sudden end to government guaranteed mortgaged backed securities would be an economic disaster. Housing and housing related services accounts for over 17% of the country’s Gross Domestic Product. The progression that begins with buyers who can only afford smaller mortgages and moves to lowered home values and then loss of equity and finally to recession is very familiar to everyone.

The legislation to wind down the GSEs has names like “The Protecting American Taxpayers and Homeowners” and “Housing Finance Reform and Taxpayers Protection Act” both sound like just what the country needs, but the devil is in the details. The National Association of Realtors strongly opposes these bills and other efforts that disrupt the current housing finance status quo, but the damage has been done. Less dependence on the federal government for the health of the housing sector of the economy would be a good thing, getting from here to there needs to be done carefully, very carefully.