Monday, October 31, 2011

How to Make a Modern Mortgage

A couple of days ago I heard on the radio that people very rarely pay off mortgage anymore--the WWII generation was the last generation to pay off their mortgages in significant numbers. At first I thought it was just another indicator of how lax we are, but then I thought that it actually made sense.

First of all, people rarely spend 30 years in the same place. The people who are paying off mortgages today purchased their homes when I was born. In those 30 years I've lived in six states and one foreign country. Since people are more mobile, paying the same mortgage for 30 years isn't really an option.

Second, people who would be paying off mortgages today took out those mortgages when interest rates were much higher. It would be foolish of them not to have refinanced to much lower rates. And when they refinanced, they probably did so to another 30-year term. Which leads me to my third point...

Third, refinancing, or buying a new house with a new 30-year mortgage, better meets people's time preferences of money. If you pay of a mortgage the old-fashioned way, 30 years from now you'll have a LOT of extra money. If you refinance to a new mortgage, by spreading the principle over so many extra payments, you reduce the amount your paying now. So instead of a lot of money later, you have a little more money now. I've heard this concept described as stealing from yourself when you're poor to give to yourself when you're rich. Better to use the money when you need it (when you have a mortgage) than to wait until your need for money is vastly reduced.

The problem with all of this is that houses are still too expensive proportionate to our current income to be purchased in the time frames our lifestyles provide. I've seen numbers ranging from five to ten years as the average length of time between moves, all of which are only available in ARM mortgages, which isn't the same.

I know many people would prefer that real estate ownership be left to professional landlords, as the small-business aspect of homeownership unduly reduces people's mobility. However, barring that, here's what I think a modern mortgage should look like:

  • You have a single mortgage that you take out to purchase a residence. This mortgage can follow you from property to property throughout your life--it's tied to you, not to a particular piece of real estate.
  • Your mortgage is adjustable in BOTH interest rate AND principle. If you want to purchase a more expensive residence than your mortgage and equity can cover, they can loan you more. If you purchase a less expensive property, you can put the extra into equity. The interest rate can fluctuate (you can set rules, like it can only vary so much year-to-year, for example).
  • Your mortgage is interest-only forever. Rather than having a set term, you pay only the interest, taxes, and fees every month. If you decide to pay off some of the principle, your next payment will be reduced, as you'll have less interest to pay.
As a result, you'd have a mortgage that fits modern lifestyles and people's time preferences for money. You could build equity as you saw fit, moving from apartment to condo to house and back again.


Blogger Noumenon said...

I can easily imagine some economist blogger posting this idea and explaining how it's exactly equivalent to the idea of student loans or something. Debt financing is weird. But it needs a catchy name, like a "dwelling security account" or something.

11:40 AM  
Anonymous TSR said...

What happens in retirement, if you don't own a home? You still have to make mortgage payments, but on reduced income. If the plan is to have enough equity by then to buy a home outright, I see no advantage over the current system.
The problems with lifestyle debt financing is that you lose lifestyle flexibility.

11:31 PM  
Blogger Octavo Dia said...

Sorry for not responding to this sooner, TSR, but you'd be in no worse shape than the typical city dweller who rents their entire life.

10:14 PM  

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