Wanted: a loan to take into retirement

No perfect mortgage for borrowers whose income will drop

By Jack Guttentag, Monday, February 15, 2010.

Inman News 

"I am 58 years old and looking to buy a new home. I won't be able to pay off this home before I retire, but I would like my payment to drop at retirement because my income will drop. I was thinking that a combination of a 15-year and a 30-year mortgage might work for me because the 15-year portion would be paid off about the time I retire. What do you think of this idea?"It is interesting. If you borrow $100,000 at 5 percent for 30 years, your payment is $537 for 30 years. If you take a 15-year at 4.5 percent, the payment is $765 for 15 years. If you borrow $50,000 of each, the payment is $651 for the first 15 years, and $269 for the next 15 years. This is the kind of deal you are looking for. Obviously, the portion of the combination that is 30 relative to the portion that is 15 could be adjusted to the circumstances of the borrower.To my knowledge, however, no lender is offering this kind of combination loan. The major thrust of mortgage innovation has long been to find ways to reduce early-year payments, at the expense of higher payments in later years. All such mortgages carry additional default risk because they all carry delays in paying down the loan balance. In contrast, the combination loan you are looking for would reduce default risk because of larger payments in the early years, and should therefore be attractive to lenders. Presumably the reason it doesn't exist is that nobody thinks there is much of a market for it. In this, they may be wrong. Of the mortgages now available in the market, the one that comes closest to meeting your needs is the 10/1 adjustable-rate mortgage (ARM). This loan has a fixed rate for 10 years, and when the rate is adjusted, a new payment is calculated that will fully amortize over the remaining 20 years. The new payment is based on the balance after 10 years, so the extra payments you make during the first 10 years will result in a lower payment starting month 121. Further, after 10 years, the payment is recalculated annually with a new interest rate, so that any extra payments made during the year will reduce the payment in the following year.The weakness of the 10/1 ARM for your purpose is that every recalculation of the payment is made at the then-current interest rate, and a rise in rate could offset the effect of your extra payments. The risk is considerable. While rates can go up or down, over the next 10 years they are much more likely to go higher than lower.What is needed to meet your needs is a mortgage that operates like an ARM in having the payment recalculated at periodic intervals, but with a fixed rate for the life of the loan. The initial payment period could be set to equal the borrower's high-income period. At the end of that period, a new payment would be calculated that would be lower to the extent that the borrower had made extra payments during the first period. This would be a very simple instrument designed to meet a specific market need.Will the New Good Faith Estimate (GFE) Reduce Third-Party Settlement Costs?Third-party settlement charges are charges for services that lenders require borrowers to purchase. They have always been overpriced because the lender has usually selected the service provider and the borrower has paid the tab. This results in "reverse competition," where service providers compete for the favor of lenders, which raises their costs and prices. The obvious, simple and direct remedy is to require that lenders themselves purchase all third-party services they require borrowers to have. Lenders would pass the cost on to borrowers in the mortgage price, but it would be far smaller than it is now because lenders are informed buyers who would buy in bulk and drive down prices. It is the same reason why car buyers pay less for tires when the tires are purchased by the manufacturer and included in the price of the car. Instead of doing the obvious, Congress declared that fees paid by service providers for the referral of business were illegal, as if this would encourage service providers to reduce prices. It hasn't. In the new GFE that became effective Jan. 1, HUD tries another tack. It requires lenders to distinguish third-party charges of service providers that the lender selects, and charges of providers selected by the borrower. Charges in the first group cannot be more than 10 percent higher at closing than the estimate shown on the GFE. There is no such limit applicable to the charges of service providers selected by the borrower.The 10 percent limit on price increases will eliminate the practice of "lowballing" these charges, which some lenders did as a way to entice borrowers who shopped total settlement costs. But it will not reduce these charges. The explicit recognition of the two categories of charges may induce more borrowers to shop, and more service providers to market directly to borrowers. Over the years, this could put some downward pressure on prices. This is about the bes
t HUD could do, because it does not have the legal authority to require lenders to purchase all third-party services themselves. The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.