You Spin Us Right Round

1 02 2013

America

WSJ Market Watch:

No-money-down mortgages are back

Some affluent buyers are getting the keys to their new home without putting a penny down.

It’s 100% financing—the same strategy that pushed many homeowners into foreclosure during the housing bust. Banks say these loans are safer: They’re almost exclusively being offered to clients with sizable assets, and they often require two forms of collateral—the house and a portion of the client’s investment portfolio in lieu of a traditional cash down payment.

In most cases, borrowers end up with one loan and one monthly payment. Depending on the lender and the borrower, roughly 60% to 80% of the loan can be pegged to the home’s value while the remaining 20% to 40% can be secured by investments. On a $2 million primary residence, for instance, the borrower could get a $2 million loan, which would require a pledge of assets in an investment portfolio to cover what could have been, say, a $500,000 down payment. The pledged assets can remain fully invested, earning returns as normal, without disrupting the client’s investment goals.

While these affluent clients may be flush with cash, this strategy allows them to get into a home without tying up funds or making withdrawals from interest-earning accounts. And given the market’s gains combined with low borrowing rates in recent years, some banks say clients are pursuing 100% financing as an arbitrage play—where the return on their investments is bigger than the rate they pay on the loan, which can be as low as 2.5%. Some institutions offer only adjustable rates with these loans, which could become more expensive if rates rise. In most cases, the investment account must be held by the same institution that’s providing the loan.

“No fair!”  I can hear the Congressional Black and Hispanic Cauci whining right now.  These aren’t really “no down payment” mortgages, these are “no money down” mortgages.  Big difference.  But they won’t result in “deprived minorities” getting to buy houses.

But still, I don’t approve.

Why?

Because it means that quantitative easing is going to have to continue to keep the investments and securities markets’ indexes high, so that the investments and securities necessary to sling as a quasi-down payment at least hold their “value” over the life of the mortgage, and of course everyone else will have to bear the cost vicariously with everything we buy.  And if some banks are only offering these kinds of loans as ARMs and never fixed rates, this means that governments’ iron-fist manipulation of both the interest rate market to keep interest rates low to make it cheap for governments to borrow money (e.g. LIBOR), and also the current normal good-inferior good jiggering around with the CPI (to keep it as low as possible to keep Social Security COLAs as low as possible and to keep the income tax bracket boundaries from soaring too much from year to year to keep income tax revenue high enough) better keep on going for a long time.

This is going to go splat some how some way, maybe sooner than we think.  I bet RJP already knows the answer.

Until he provides it for us…five, six, seven, eight…the extended club mix at that:

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5 responses

1 02 2013
Puggg

This doggy smells the fire hydrant, and comes away with this:

Slow and steady wealth transfer from everyone who ever buys anything to people in the relative high end of the real estate market.

1 02 2013
rjp

I do not have a problem with secured borrowing against non-volatile assets; equities are generally volatile, bonds are going to get volatile as soon as QE and other funny stuff comes to an end. The story does say the banks do address this.

Where I have the problem is with the Mortgage Interest Deduction:

Field Guide to Mortgage Interest Deduction
(Updated January 2013)

…. the Mortgage Interest Deduction (MID) allows homeowners who itemize their taxes to deduct mortgage interest attributable to primary residence and second-home debt totaling $1 million, and interest paid on home equity debt up to $100,000. ……

Source: http://www.realtor.org/field-guides/field-guide-to-mortgage-interest-deduction

Scenario: Income to borrow to buy a $2mm home. The bank lends full value essentially because I secure $800k with investments. In essence, I have borrowed $800k from myself through a second party.

As government does not require income tax to be paid on the interest portion paid, the government is rebating me the income tax paid on a value equal to 40% of the interest on the principal secured by assets.

Now, here’s where it gets interesting, because I am sure the bank gets their money first:

Let’s suppose there are 10 million households in the US that had income and net worth to participate in the above scenario, and do.

This equals $8,000,000,000,000 in securities that can’t be sold and converted into cash, a value equal to one half of US GDP that must remain invested for ~23 years, while being given a government subsidized return on investment though income tax deductions.

Using ARMs though is insane.

Traditionally interest rates and market indices moved in the same direction. What is going to happen eventually though is interest rates will go up, since markets can only be intervened in for so long. Which means people will pay more to borrow, and have less to spend on goods and services, and this will be reflected negatively by the equity markets. So the borrowers of the above will see their mortgage payments go up at a time when the assets securing their loan are going down in value, margin call time.

Now the rise in interest rates will result in a larger mortgage interest deductions ….. meaning decreased government revenue. Without continued intervention in markets, nothing good can come of this for the borrowers or the government.

1 02 2013
rjp

I should clarify here, that in the final sentence, the word “borrowers” means the above borrowers, the kinds of people who routinely make the maximum donation allowed to a political “ally”.

2 02 2013
jillparish

This just lightened up my day. Mae me smile:)

2 02 2013
jillparish

Oops!! can’t spell sometimes. Made not Mae. Oh well #### happens.




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