01 June, 2008

What, me? subprime?

A friend of mine in the Washington, DC area told me a few years back that his cousin was getting involved in the real estate market: he and a few friends planned to pool their money, buy a house, (maybe) do a few improvements to it, then sell it after half a year or a year & reap a profit based on the rising home values. They didn't plan to use it as a home; it was merely an investment based on speculation. I don't remember what my reaction was at the time, but I do wonder whether his cousin's finances survived the recent, sharp decline in home values in that area.

I keep reading that part of the trouble in the current housing market is that lenders were issuing mortgages to borrowers who made zero down payment. For example, an article in today's Washington Post states,

[I]f [lenders] could steer unsuspecting prime borrowers into subprime loans, they could even inflate the subprime market itself. So lenders paid mortgage brokers a kickback for steering borrowers into higher-priced loans. Lenders also slashed downpayment requirements from 10 percent to 5 percent and even to zero.
I keep seeing these figures associated with "subprime", and I start wondering if my mortgage counts as a subprime mortgage. After all, I made no down payment.

Why not? I had no savings for a down payment. Why not? Let's not digress.

In October of 2006, I was paying $700-$750 per month in rent. I know the formulas involved in paying off a loan (they are publicly available; you can find simple calculators online if you want) so I sat down & figured what sort of house I could afford at that rate. Property tax and fire insurance raise the monthly price somewhat, of course, but I had some breathing room, because $750/month still constitutes a monthly payment on a decent house in most parts of the country, in particular this one.

Because I had no money for a down payment, my potential mortgage broker (Member One Federal Credit Union) explained to me that I had two options:
  1. I could pay PMI (a mortgage insurance for people without enough money for a down payment), or
  2. I could take out an additional loan (Home Equity Line) to cover the down payment.
I chose this second option. She made it quite clear to me that this second loan would be a ten year loan at a higher interest rate (approx. 2% higher than the mortgage) and that at that time almost half of the loan would still be outstanding, so I would have to pay it off or refinance it somehow.*

I took the offer. Since then I have paid more on that loan than the minimum.** I'm on track to finish paying that Home Equity Line in approximately 6 years now, well before the due date.

The question arises in my mind, is my mortgage a subprime mortgage? I don't know, but it troubles me that people advocate putting a stop to zero-down mortgages as part of the solution to the current troubles. Had that been the practice in November 2006, I wouldn't have a house now; I'd still live in a 1000-sq. ft. apartment, paying ~$700/month on rent, putting away $200-$300 dollars a month into savings, and at that rate maybe—maybe—in five years I'd have saved enough to make a ten percent down payment. I can't have been the only person in this situation to take advantage of an offer that I could afford.

Still, maybe people like me shouldn't have a house? Admittedly, from a perspective strictly of finance, having less equity in the house makes one more of a risk. This view is flawed. Unlike my friend's cousin, I am not a speculator trying to flip a mortgage; I am a father, trying to provide his family with a home. Rational people do not look at their homes strictly from a perspective of finance; they look at their homes as: homes.

In addition to paying my mortgage and paying that HEL early, I have improving the house a little, because I want my wife and children to live in a nice place (minor repairs, painting, wood floors, tiling the walls of a bathroom). I have enough left over to put some money into savings. How is a family like mine too high a risk for lenders?

Contrast this to a woman I heard on NPR the other day. A broker helped her obtain a mortgage to a house where she paid $2,000 a month on her mortgage. Her annual income is $26,000/year. That won't leave her with enough money to pay for groceries, bills, and the rest. No sane mortgage company would have given her a loan based on that information, but according to the story on NPR her mortgage broker showed her how to trick the mortgage company into thinking she had a higher income than she had. Two questions come to my mind:
  • How could her mortgage company not be bothered to check her income more robustly?
  • How did it never occur to the woman that the broker was telling her to lie, and that lying is wrong?

This is a real mess for some people, isn't it? I feel some sympathy for the woman, who sounded a bit old and may have let herself get talked into this. I draw the line, however, when people who claim to be protecting her say that the solution is to stop responsible people from buying a home. Banning zero-down mortgages is not a solution to the current crisis.

*I've wondered if this is something of an accounting trick. I had no money for a down payment, but my mortgage broker (a credit union) was willing to extend me the money for a down payment so that I could avoid PMI. I reckon that it would look to the company offering the mortgage (Homecoming Financial, LLC) as if I had the money for a down payment, even though that money came from a Home Equity Line of credit on a home that I didn't actually own yet.

**I've read that people advise against paying more than the minimum on a mortgage, but I have reasons for it.

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