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6 September 2004
"I�m surprised that you have never written
about Fannie Mae�s new Payment Power program. It allows borrowers to skip
payments, an option you have said was badly needed."
On many occasions, I have indeed lamented the
lack of payment flexibility in mortgages. The Payment Power program (PPP),
however, is a poor first step toward flexibility. I am not sure whether it will
advance the cause or retard it.
The PPP allows a borrower to skip up to 2
mortgage payments in any 12 month period, and up to 10 over the life of the
loan. When a payment is skipped, the amount is added to the balance and a new
(slightly higher) payment is calculated over the period remaining to term. In
effect, the lender is making an additional loan, equal to the payment, at the
original loan rate.
This would be a nice option to have if it
were free, but in fact it is very costly. Lenders charge both an upfront fee and
a usage fee � some charge a high upfront fee and low usage fee and others do the
opposite. I would look for the lowest upfront fee myself, since I wouldn�t
expect to use the feature except in an emergency.
One of the lenders offering PPP is Indy Mac,
which charges an upfront fee of only 1/8 of 1% of the loan. Its usage fees,
however, are on the high side, ranging from $ 225 to $355, depending on the loan
balance. As an example, the monthly payment on a 6% loan for $166,792 would be
$1,000, and the usage fee (until the balance fell to $120,000) would be $295.
That is an upfront charge of 29.5% to borrow $1,000 at 6%!
Paying $295 is better than becoming
delinquent, but you would be far better off drawing on a home equity line of
credit (HELOC) if you have one. If you don�t have one, so long as you have
unused equity in your home and your credit remains good, you can always get one.
Just don�t wait so long that you become delinquent before the HELOC is approved.
Even better is having free insurance coverage
for involuntary unemployment and disability, which you have now if you are
paying for mortgage insurance and the carrier is MGIC. Under MGIC�s Mortgage
Payment Protection Plan, within the first 5 years of your loan, MGIC will make
your monthly payment up to $2,000 a month if you lose your job or become
disabled for more than 30 days. The limit is 9 monthly draws for a maximum
payout of $ 18,000. Anyone covered by this plan would be foolish to pay anything
at all for a Payment Power loan.
The premise underlying Payment Power is that
the best way to provide a source of funds that a borrower can tap in an
emergency is to allow him to borrow these funds, at very high cost. My view is
that a truly flexible mortgage would provide a far better source of funds -- one
that borrowers generate themselves, by making larger-than-scheduled payments. If
you pay more this month, you should be able to pay less next month.
This type of mortgage would base the
borrower�s payment obligation on the loan balance. A schedule of required
balances, declining month by month over the life of the loan, would be part of
the contract. If the borrower made all the scheduled payments, his balances
month by month would correspond exactly to the required balances. But if he paid
more in some months, his actual balance would fall below the required balance,
providing a "reserve account" which he could draw on by paying less later on.
Interestingly, the underwriting requirements
for many existing loan programs require borrowers to demonstrate that they have
a cash reserve equal to several months of payments. But once the loan is funded,
the borrower is not permitted to build such a reserve by making payments in
excess of the scheduled payment. That makes no sense. It also makes no sense
that borrowers who prepay a chunk of their mortgage balance can�t reduce the
payment instead of shortening the term.
The fact is that our current mortgage was not
designed to facilitate mortgage management by borrowers. It was designed to
facilitate servicing by lenders. This had a rationale when servicing was a
manual procedure by guys with quill pens and green eyeshades, but it has no
rationale today.
Read
How Would a Truly
Flexible Mortgage Work?
Copyright Jack Guttentag 2004
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