Trump proposes 50-Year Mortgage

[superrific]

None of these explanations are correct. The bank could charge interest and principal at any schedule you and it agree to. You could pay all interest one month, and then all principal the next, and then half/half and then skip two months and have a big 3 month lump sum. So "math" isn't the explanation.

The explanation is that people like to have a monthly payment that doesn't jump up and down. It's also sound underwriting practice (though by no means the only one possible), so the "same payment every month" becomes the boundary condition. AT THAT POINT the math dictates the repayment schedule.

I don't know to what extent regulations require mortgages to be structured this way, but the primary reason that mortgages are standardized is to make them easier to trade on a secondary market. When you know the repayment schedule is standard, then interest rate and LTV is most of what you need to know to get a decent valuation given a particular owner's credit history.

 

[Calheel]

None of these explanations are correct. The bank could charge interest and principal at any schedule you and it agree to. You could pay all interest one month, and then all principal the next, and then half/half and then skip two months and have a big 3 month lump sum. So "math" isn't the explanation.

The explanation is that people like to have a monthly payment that doesn't jump up and down. It's also sound underwriting practice (though by no means the only one possible), so the "same payment every month" becomes the boundary condition. AT THAT POINT the math dictates the repayment schedule.

I don't know to what extent regulations require mortgages to be structured this way, but the primary reason that mortgages are standardized is to make them easier to trade on a secondary market. When you know the repayment schedule is standard, then interest rate and LTV is most of what you need to know to get a decent valuation given a particular owner's credit history.

Of course the bank and borrower COULD agree to any schedule. But it is math/amortization that governs the analysis. You could call a portion of the repayment "pink tacos" and it wouldn't change the math that the $500k needs to be repaid and until it is repaid, the implied interest on $500k is a heck of lot more than the implied interest on $400k. That is the basic math point.

 

[superrific]

It is not about banks being greedy. It is about alternative uses of capital.

If one method of deploying capital only allows you to collect 47k and another method allows you to collect 77k, the capital will be deployed to the highest and best use.

You are borrowing all of the $500k at the outset of the loan. That means all of the $500k is tied up in an asset in which you get to capture 100% of the appreciation and accept virtually no downside risk on depreciation due to anti-deficiency laws.

Why would financial institutions participate in a lending market in which they are only allowed to collect a portion of the FMV of their funds? They will deploy those funds to the highest and best uses, which may be hedge fund investments or similar. Or alternatively, they will charge absurdly high interest rates so that they net out to the same place as before the government intervention.

Eh, it all washes out in the end. The bank doesn't care about principal versus interest. The bank just wants to recoup $X over Y years of repayment. You could do that with a higher interest rate and quicker principal paydown. You have an equation with two variables, so there are multiple solutions. There needs to be another constraint to hold it down.

Foreclosure could alter that equation, but I don't think that necessitates any particular type of repayment schedule. The "same every month" payment is what locks it down. Well, that and simplicity. I think you can solve for equal monthly payments if you are willing to compromise elsewhere, but then you have a messy thing that people won't understand and it would be ripe for fraud. So truth-in-lending laws necessitate something simple.

 

[SnoopRob]

It is not about banks being greedy. It is about alternative uses of capital.

If one method of deploying capital only allows you to collect 47k and another method allows you to collect 77k, the capital will be deployed to the highest and best use.

You are borrowing all of the $500k at the outset of the loan. That means all/most of the $500k is tied up for the initial period of the loan. Why would financial institutions participate in a lending market in which they are only allowed to collect a portion of the FMV of their funds? They will deploy those funds to the highest and best uses, which may be hedge fund investments or similar. Or alternatively, they will charge absurdly high interest rates so that they net out to the same place as before the government intervention.

Again, I'm not advancing this idea as one that wouldn't have significant market impacts, just one that a lot of folks would see the value in and would advocate for.

You're arguing it's a bad idea, I'm merely explaining why it would be appealing to many folks for whom "financial details" might as well be synonymous with "magic incantation".

 

[superrific]

Of course the bank and borrower COULD agree to any schedule. But it is math/amortization that governs the analysis. You could call a portion of the repayment "pink tacos" and it wouldn't change the math that the $500k needs to be repaid and until it is repaid, the implied interest on $500k is a heck of lot more than the implied interest on $400k. That is the basic math point.

Nah. It's a contract. It's malleable. The math only gives you a single answer if you assume equal payments per month + simplicity.

 

[Calheel]

Nah. It's a contract. It's malleable. The math only gives you a single answer if you assume equal payments per month + simplicity.

Again, you can call it pink tacos. The bank wants a ROI on its principal. That is the math part.

 

[superrific]

To be clearer, think about Treasury bonds. They pay a recurrent coupon and then a lump sum at the end. Or a zero, which doesn't pay any coupon at all. The repayment schedule is set by boundary conditions, and if the boundary conditions are relaxed, then there are multiple equilibrium configurations

 

[ChapelHillSooner]

None of these explanations are correct. The bank could charge interest and principal at any schedule you and it agree to. You could pay all interest one month, and then all principal the next, and then half/half and then skip two months and have a big 3 month lump sum. So "math" isn't the explanation.

The explanation is that people like to have a monthly payment that doesn't jump up and down. It's also sound underwriting practice (though by no means the only one possible), so the "same payment every month" becomes the boundary condition. AT THAT POINT the math dictates the repayment schedule.

I don't know to what extent regulations require mortgages to be structured this way, but the primary reason that mortgages are standardized is to make them easier to trade on a secondary market. When you know the repayment schedule is standard, then interest rate and LTV is most of what you need to know to get a decent valuation given a particular owner's credit history.

First, our explanations are not correct.

Using your example, if you paid all principal the first month and then interest the second month, what happens to the interest that accrued that first month? It would get added to principal and the borrower would be in the same boat. That example is just calling a dog a cat.

That is unless the lender just said, you know what we won't charge interest every other month but they're not going to do that. If they did, they would have to return lower interest on the securities that fund the loan and people wouldn't buy those securities so the lending institution would run out of capital.

 

[Calheel]

Again, I'm not advancing this idea as one that wouldn't have significant market impacts, just one that a lot of folks would see the value in and would advocate for.

You're arguing it's a bad idea, I'm merely explaining why it would be appealing to many folks for whom "financial details" might as well be synonymous with "magic incantation".

It is not that is just a bad idea, it is that it is sophistry. If you somehow altered the amortization schedule by government fiat, you are playing either a semantic game or a mathematic game. And either way, you'd end up in the same spot (at best).

 

[superrific]

Again, you can call it pink tacos. The bank wants a ROI on its principal. That is the math part.

So why doesn't the bank require all interest to be paid down before any of the principal, like in a corporate bond? That is consistent with an ROI. It gives the bank its full interest. So why not?

 

[superrific]

Note that most buyers should prefer the upfront loading. Since you get a tax break from interest and not principal, your house is worth more for tax purposes the earlier you are in your mortgage (assuming no caps on deductions, which was the case for a long time).

So the people who think "greedy banks" aren't right because it's not about banks exploiting consumers. If anyone should be angry, it is the taxing authority

 

[ChapelHillSooner]

To be clearer, think about Treasury bonds. They pay a recurrent coupon and then a lump sum at the end. Or a zero, which doesn't pay any coupon at all. The repayment schedule is set by boundary conditions, and if the boundary conditions are relaxed, then there are multiple equilibrium configurations

If I understand this right, the borrower is the government and the bank is the buyer of treasuries. So what happens if the borrower sells the house and wants to pay off the loan? They owe a lump sum at the end. That wouldn't solve Snoop's issue.

The way to solve Snoop's issue is to buy a smaller house and get a 10 year loan. Then a lot higher percentage of your first payment is going to principal.

Want a $1 million dollar loan for 6% per year compounded per month? You're going to pay $5000 (.5% on $1 million) in interest that first month no matter how you slice it unless you can convince the bank to do something differently.

 

[Calheel]

So why doesn't the bank require all interest to be paid down before any of the principal, like in a corporate bond? That is consistent with an ROI. It gives the bank its full interest. So why not?

There are a variety of repayment schedules theoretically possible with a home loan, but given that most home loans allow for early repayment, it is very difficult to assume a total interest amount at the outset (unlike a corporate bond or a treasury).

 

[superrific]

Using your example, if you paid all principal the first month and then interest the second month, what happens to the interest that accrued that first month? It would get added to principal and the borrower would be in the same boat. That example is just calling a dog a cat.

That is unless the lender just said, you know what we won't charge interest every other month but they're not going to do that. If they did, they would have to return lower interest on the securities that fund the loan and people wouldn't buy those securities so the lending institution would run out of capital.

It literally doesn't matter what happens to the interest rate that first month. You can have any payment schedule you want. Some bonds pay a coupon and then lump sum principal at the end. Some bonds have "sinking funds" that require a big lump sum repayment periodically -- for instance, four principal pay-down events over the course of the loan. Everything just gets plugged into a discounted cash flow analysis anyway.

The math literally says that without further specification, there are infinitely many solutions. You need a second constraint to arrive at any specific formula.

As I noted above, the current system is good for the borrower in terms of taxes, so the second constraint might be "the market reaches the most efficient solution that maximizes collective welfare for buyer and seller."

 

[Calheel]

Note that most buyers should prefer the upfront loading. Since you get a tax break from interest and not principal, your house is worth more for tax purposes the earlier you are in your mortgage (assuming no caps on deductions, which was the case for a long time).

So the people who think "greedy banks" aren't right because it's not about banks exploiting consumers. If anyone should be angry, it is the taxing authority

100%, which is why I am fine not paying any principal and have no real objection to 50 year mortgages. The value in home ownership is asset appreciation and tax advantage. Paying down the principal is a very Puritan-work ethic approach, but not the smartest financial decision.

 

[superrific]

There are a variety of repayment schedules theoretically possible with a home loan, but given that most home loans allow for early repayment, it is very difficult to assume a total interest amount at the outset (unlike a corporate bond or a treasury).

No harder than it is to assume a total interest amount without repayment. Foreclosures happen. It's all based on expected discounted cash flow, and then various ways of mitigating and hedging risk.

There is no reason that a corporate bond can't allow for early repayment (and I don't remember whether the standard debenture does or not). The market will find the most efficient solution in such a liquid and historically deep market.

I know you've heard of a revolver. That's a corporate loan with an early repayment option. They exist despite the supposed difficulty in computing total interest.

 

[ChapelHillSooner]

There are a variety of repayment schedules theoretically possible with a home loan, but given that most home loans allow for early repayment, it is very difficult to assume a total interest amount at the outset (unlike a corporate bond or a treasury).

Right, let's say the bank gave you a loan and said the first 10 years of payments are all principal then the rest is all interest. So the loan is "paid off" in 10 years the the buyer wants to refinance or sell the house. How do you deal with that? I would imagine the loan would be structured so you still owe the bank a crap ton of money. So you really haven't paid off the loan. Again, you are just calling a dog a cat.

 

[Calheel]

No harder than it is to assume a total interest amount without repayment. Foreclosures happen. It's all based on expected discounted cash flow, and then various ways of mitigating and hedging risk.

There is no reason that a corporate bond can't allow for early repayment (and I don't remember whether the standard debenture does or not). The market will find the most efficient solution in such a liquid and historically deep market.

I know you've heard of a revolver. That's a corporate loan with an early repayment option. They exist despite the supposed difficulty in computing total interest.

There is also a very liquid secondary market for bonds and treasuries that does not exist with individual mortgages.

At the end of the day, whatever financial debt instrument is involved, the issuer is going to want a mathematical return for the use of the capital. You can't have a Snoop product that says "Hey bank, you've made enough" without it significantly altering the interest rate or removing the product from the market.

 

[superrific]

There is also a very liquid secondary market for bonds and treasuries that does not exist with individual mortgages.

At the end of the day, whatever financial debt instrument is involved, the issuer is going to want a mathematical return for the use of the capital. You can't have a Snoop product that says "Hey bank, you've made enough" without it significantly altering the interest rate or removing the product from the market.

I have no idea what a Snoop product is.

There is a liquid secondary market for mortgages. Banks rarely keep the whole loans on their balance sheets. They syndicate them or securitize them or off-balance sheet them in other ways.

At the end of the day, a loan is a cash flow. For a 30 year loan, that's 360 monthly payments. Plug them into a spreadsheet, calculate NPV, and you can change the sums around however you choose equivalently so long as the NPV stays the same. To a first approximation. If you're sophisticated in finance, you'd also want a risk profile, but for the most part that's a single equation plus data, unless there are other complicated synthetics.

Yes, the creditor (not the issuer) is going to want a competitive risk-adjusted rate of return. That single parameter doesn't mandate any sort of payment schedule. There needs to be further specification, as the spreadsheet example shows.

 

[Calheel]

I have no idea what a Snoop product is.

There is a liquid secondary market for mortgages. Banks rarely keep the whole loans on their balance sheets. They syndicate them or securitize them or off-balance sheet them in other ways.

At the end of the day, a loan is a cash flow. For a 30 year loan, that's 360 monthly payments. Plug them into a spreadsheet, calculate NPV, and you can change the sums around however you choose equivalently so long as the NPV stays the same. To a first approximation. If you're sophisticated in finance, you'd also want a risk profile, but for the most part that's a single equation plus data, unless there are other complicated synthetics.

Yes, the creditor (not the issuer) is going to want a competitive risk-adjusted rate of return. That single parameter doesn't mandate any sort of payment schedule. There needs to be further specification, as the spreadsheet example shows.

A Snoop loan is what started this tangent. It is when the bank doesn't get to charge all of its interest in the first few years of the loan and needs to defer a portion of the interest until later in the loan, so that the homeowner can build equity faster.