Why so many sub-prime loans went bad

Maybe nothing, maybe securitization. More banks package their loans and sell them than keep them. In which case, you'd agree that you're not going to find mortgages of non-five-year-multiple to be easily combined.

So we have 15 and 30 as most common, with some 20 year mortgages available. I've shown that the savings are less for each year you add, and a 50 year mortgage is close to an interest only. Annecdotal evidence tells me very few people buy a house and pay the mortgage for its entire duration. I'm here 11 years and on my 4th mortgage, all no point no closing refies. Avaerage time in a home is 7 years, so people are doing a lot of moving around.

JOE

My guess is 30 years was just about the average homeowner's working life, post buying the home. But that's only a guess.

I just googled about FHA

Japan got to 50+ year loans at the peak of the housing bubble. You would buy a house, and will it and your mortgage to your children.

If I

And yet there is a huge market hole there, for very long duration liabilities-- insurance companies and pension funds. You need an offsetting asset, and there are none.

If you could package the mortgages up (to reduce credit risk) then you could do it. Some utility companies are offering very long term bonds, but generally lenders (investors) want the best credit level, ie government.

Analagously, infrastructure investing has taken off. Infrastructure (toll roads, water pipes etc.) is a very long lived investment, with long duration. This matches nicely the liability problem of even a fairly mature pension fund.

The UK government offered a 50 year gilt and it was snapped up. A 50 indexed gilt (ie a TIPS) would be a brilliant product.

I just cannot understand the business of everyone refinancing over the past few years. Sure, it makes sense to refi. at a better rate, but it just doesn't make sense to refi. at a better rate 5-10 years into a mortgage only to refi for another 30 years, unless, one refis for a shorter term -or- puts the savings from the reduced mortgage into the payments. Sure, many people used equity to pay off debts. That's ok once. I prefer to keep my mortgage seperate from my debts and actually own my house someday.

The way I see it, If the value of my home goes up, it means that the value of the home I may want to live in when I retire has also gone up. Personally, I don't want a mortgage when I retire and I am not going to pay for someone else's either.

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Why?

Let's suppose I'm 15 years into an 8% 30-year mortgage, and I have the opportunity to refinance at 6% for 30 years. Fixed rate in both cases. Then my options include the following:

If I were in that situation, I would be willing to gamble that I can make more than 6% per year over a 30-year period, in which case option (2) would have made more sense.

How old would you be 15 years into that refinanced 30 year mortgage? (e.g., did you originally purchase the house at age 30, only to refinance at age

Elizabeth Richardson

Sure, wny not?

Well, yes; that's the point. You can view a mortgage as an investment that pays a guaranteed rate that is equal to the mortgage's interest rate, because every time you make a prepayment, you avoid having to pay future interest on the part of the principal that the prepayment retired. So prepaying a 6% mortgage is like investing money in a vehicle that pays 6%.

I don't understand the question. As long as I'm paying the mortgage, I can deduct that interest from my taxes.

Here's an example. Suppose I have a mortgage, and I come into possession of a sum of money that is exactly sufficient to pay it off. Suppose further that if I wish, I can invest that money in a way that is guaranteed to pay the same amount of interest as the mortgage rate.

Now, let's compare two scenarios:

It should be clear that in scenario (2), the interest each month will be equal to the interest due on the mofrtage for that month. So if I want, I can make the entire payment by withdrawing enough from my investment to cover it, and doing so will decrease my investment by exactly the same amount as my mortgage payment decreases the remaining balance due on the mortgage. Moreover, although the interest from the investment account is taxable, the interest I pay on the mortgage -- which is the same amount! -- is tax deductible.

So under these assumptions, it's a wash. Whether I pay off the mortgage immediately or invest the money and pay it off over time, I wind up with the same amount of money in the end. It should therefore be clear that if my investment makes *more* than the mortgage interest rate, I am better off by keeping the mortgage, and if it makes *less* than the mortgage interest rate, I am better off paying off the mortgage.

Now, we started out by talking about a 6% mortgage, so the question is how likely it is to find an investment vehicle that will make 6% or more per year over a 30-year period.

I claim that the odds are pretty good. For example, if you look at

Now of course, as they say, past performance is no promise of future results. Nevertheless, there is quite a gulf between 6% and 13.1%, which is why I say that it's a pretty good bet that one can make more than 6%/year, on average, over the next 30 years. It's not guaranteed, but I like the odds.

There is a third choice that explains why Foobar has a problem with these refis. That is to make the minimum payments on the new mortgage and spend the difference on consumables. In that case, you will not be ahead, yet that is by far the most common choice made.

Well, sure. But one can forestall that choice by setting up an automatic investment plan, which automatically transfers the difference between the old and new mortgage payments into your investment account :-)

More seriously, I don't think it's quite far to respond to a claim of the form "A is better than B" by saying "Yeah, but C is even worse than A or B, and B leaves open the possibility of C where A doesn't." That response may well be true, but it doesn't affect the truth of the original claim.

And Kotlikoff ("Mr. Consumption Smoothing") might just approve of this.

I don't endorse or discredit this scenario without knowing the rest of the client's situation. My issue is with those who refi into a new $300K mortgage and blow the $50K they had in equity. This 'fourth choice' is probably more common than the one you describe, unfortunately.

JOE

Ah, but you're not paying the mortgage - you refinanced. If you had been paying the mortgage, then, when you retired, you're not paying any mortgage. When you're retired and not paying the mortgage, you're not taking that money out of your tax-deferred savings and you're not paying taxes on an extra distribution - a distribution for which you've had to save above and beyond your needs if you'd just paid the mortgage in the first place instead of refinancing. And, remember, your tax-deductibility on the mortgage isn't really giving you anything except the privilege of not paying money that's going out the door to the bank and, for which, you're getting little benefit.

Elizabeth Richardson

However, I don't think that Foobar was claiming that B was better than A. I think that Foobar was saying that B was better than C, then you piped in with "but A is even better!" I was simply saying that I think Foobar was comparing different choices than you were.

Or you might have to option to refinance for 15 years for 5 5/8 percent.

-- Doug

I agree with your summation, but you have changed the scenario. How about this instead, suppose you did not come into possession of that sum of money.

Assume you are 15 years into a 30 year mortgage, $300K at 8%

The choices are:

A) Continue making payments of $2201. B) Refinance into another 30 year at 6% and continue to make $2201 payments. C) Refinance as above but make $1381 payments and invest $820 in a vehicle that earns a 6% return.

With option (a) you pay off the house in 15 years (b) you end up paying off the house in about 12.5 years (149 months,) with option (c) you pay off the house in 30 years and have a $824K nest egg.

Options (b) and (c) are obviously both better than option (a), but is one of them better than the other? What if, for example ones income decreases sharply 10, 15, or 20 years down the road?

If I'm doing the numbers right, someone who chooses option (c) will have enough in his investment to pay off the house in only 8 years, is that right? If that is the case, then I'd say that option (c) is still the best solution for future proofing ones life.

If one can invest at the same rate as borrowing, as in (C), it's a wash. There would be no advantage to paying the mortgage instead, and the investment built can help in the low-income scenario. But right now the risk free rate is just over 5%, and we are back to the 'pay the mortgage early' vs 'invest the cash' dialog which has been tossed around here a few times already. I've moved to the Elizabeth camp on this, that one should target to have no mortgage in retirement. The wealthy over-saver is the exception, but a statistical outlier, who isn't reading this NG anyway. JOE

Now, there's a refi that makes sense. I purchased my house back when interest rates were very high - mine was a 30 year at 13-5/8%, and that wasn't as bad as they got. 7 years into it, we refinanced to a 15 year at

Elizabeth Richardson

It only makes sense if one applies the reduced payment to the current mortgage.

Most refis don't work that way. Gee, I can save 300.00 a month. Now we can buy that car we talked about :-)

Could be. I'll readily agree that refinancing is a bad idea if you use it to give you money that you then throw away :-)

Which means that I now have a new mortgage that I'm paying.

I'm sorry, but I have no idea what you're talking about. I never said anything about tax-deferred savings.

That makes the comparison a little more complicated :-)