Column Delivered October 22,
2001
�The
city of Burbank has a Mortgage Assistance Program that offers home buyers
a 30-year second mortgage loan, with zero interest and no payments for the
first 5 years. After 5 years,
the second must be repaid over 25 years at 5%.
In exchange, the city receives a share of the appreciation in the
house when it is sold. The
share is equal to the amount of the second mortgage as a percent of the
sale price. For example, if
the house is purchased for $250,000 (the maximum allowed) and the buyer
takes the maximum second mortgage of $35,000, the city would take 14% of
the difference between $250,000 and the price at which the house is sold.
The buyer must put 3% down. Is
this a good deal for home buyers?�
The
Burbank program is similar to programs offered by a number of other cities
in California and Oregon. They
are a type of �shared appreciation mortgage� or SAM, similar to SAMs
offered by private lenders. Where
the private programs offer an interest rate concession on the first
mortgage, the Burbank program offers an interest rate concession on a
second mortgage.
It�s a
pretty good deal, although the $250,000 price ceiling limits the number of
households that can use the program.
There are also income limits, currently $62,500 for a household
with 4 or more persons.
The
second mortgage under the Burbank program has two advantages.
The terms are highly favorable � especially the 5-years of zero
interest. In addition, the
second mortgage reduces the mortgage insurance premium on the first
mortgage.
Mortgage
insurance premiums are based on the ratio of the first mortgage loan
amount to property value. A
standard 30-year fixed-rate mortgage with 3% down has a loan-to-value
ratio of 97%, and the mortgage insurance premium is about .9%.
Under
the Burbank program, assuming 3% down and a second mortgage equal to 7% of
price, the loan-to-value ratio is 90%, and the mortgage insurance premium
is about .4%. If the second
mortgage is 12% of value, the loan-to-vale ratio is 85%, and the premium
is about .3%.
I
developed a spreadsheet that compares the total cost to the borrower under
the Burbank program, year by year, with the costs under conventional
financing. These comparisons
led to the following conclusions:
1.
In most cases, only second mortgages of 7% or 12% of price are
worth considering. A second
for 14% of price, for example, requires the same mortgage insurance
premium as a 12%, but the borrower must give up more appreciation.
2.
Borrowers who expect to be in their house a relatively short time
do better than those who expect to stay indefinitely.
This is partly because of the 5 years of zero interest on the
second mortgage. In addition,
the number of dollars lost through the shared appreciation grows over
time.
3.
Under the Burbank plan, monthly payments are 10-12% below those on
conventional financing for 5 years. Borrowers
who can invest the monthly payment savings at high yields will do better
than borrowers who spend the savings or invest them at low yields.
4.
Borrowers who expect modest appreciation will do better under the
Burbank plan than those who expect rapid appreciation.
However, to wipe out the advantage of the Burbank program,
appreciation usually has to exceed 5-6% a year.
Here
are a few concrete examples. They
assume a $250,000 house, and that the alternative to the Burbank program
is a $242,500 conventional 30-year loan at 7.5%.
I converted the mortgage insurance premium advantage of the Burbank
program into interest rate equivalents.
The rates are 7% on a second mortgage for 12% of price, and 7.1%
for a second of 7% of price.
Smith
takes a second for 7% of price, assumes 6% price appreciation, and 3%
return on monthly payment savings. He
saves money on the Burbank if he sells before 253 months.
The maximum saving of $4718 is reached at 119 months.
Jones
also assumes 6% price appreciation and 3% return on savings, but he
takes a second for 12% of price.
He saves money on the Burbank if he sells before 186 months, and
the point of maximum saving is also earlier at 61 months.
The maximum saving is larger, however, at $5390.
Peters
also takes the 12% second but assumes 7.5% return on payment savings.
If his house appreciates by 6% or less, his cost savings rise every
month for 30 years.
Readers
who would like an estimate that meets their situation can write me.
But don�t ask for the spreadsheet, it is too user-unfriendly.
Copyright
Jack Guttentag 200
