Tag Archives: credit card debt

Understanding Homeownership

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The Housing Finance Policy Center at the Urban Institute released its House Finance at a Glance Chartbook for December. It states that financial education “can help reduce barriers to homeownership.” As I argue below, I do not think that financial education is the right thing to emphasize when trying to get people to enter the housing market.

The Introduction makes the case for financial education:

While mortgage debt has been stable to marginally increasing, other types of debt, particularly auto and student loan debt have increased far more rapidly. Our calculations, based on The Federal Reserve Bank of New York’s Quarterly Report on Household Debt and Credit, show that over the past 5 years (Q3 2012 to Q3 2017), mortgage debt outstanding has grown at an annualized rate of 1.3 percent, while non-mortgage debt (which includes credit card debt, student loan debt, auto debt, and other debt) has grown by 6.8 percent annualized rate. Student loan debt has grown by 7.3 percent per year while auto debt has been growing by 9.6 percent per year. In Q3 2012, the number of accounts for mortgage loans and auto loans are very close (84 million vs 82 million). By Q3 2017, the number of accounts for mortgages had fallen to 80 million consistent with declining homeownership rate, while the number of accounts for auto loans had increased to 110 million.

Another metric where auto loans have diverged from mortgages is delinquency rates. Over the past 5 years, mortgage delinquencies have plummeted (pages 22 and 29) while the percent of auto loans that is more than 90 days late is roughly flat despite an improving economy. However, the percent of auto loans transitioning into serious delinquency has risen from 1.52 percent in Q3 2012 to 2.36 percent in Q3 2017. While these numbers remain small, the growth bears monitoring.

When we looked at the distribution of credit scores for new auto origination and new mortgage origination, we found no major change in either loan category; while mortgage credit scores are skewed higher, the distribution of mortgage credit scores (page 17) and the distribution of auto credit scores have been roughly consistent over the period. Our calculations based off NY Fed data shows the percent of auto loan origination balances with FICOs under 660 was 35.9% in Q3, 2012, it is now 31.7%; similarly the percent of auto origination with balances under 620 has contracted from 22.7 percent to 19.6 percent. There have been absolutely more auto loans with low FICOs originated, but this is because of the increased overall volume.

So what might explain the differences in trends in the delinquency rate and loan growth between these two asset classes? A good part of the story (in addition to tight mortgage credit) is that many potential low- and moderate-income borrowers do not believe they can get a mortgage. As a result, many don’t even bother to apply. We showed in our recently released report on Barriers to Accessing Homeownership that survey after survey shows that borrowers think they need far bigger down payments than they actually do. And there are many down payment assistance programs available. Moreover, it is still less expensive at the national level to own than to rent. This suggests that many LMI borrowers who are shying away from applying for a mortgage could benefit from financial education; with a better grasp of down payment facts and assistance opportunities, many of these families could be motivated to apply for mortgages and have the opportunity to build wealth. (5)

I am not sure if financial education is the whole answer here. Employment instability as well as generalized financial insecurity may be playing a bigger role in home purchases than in car purchases. The longer time horizon as well as the more serious consequences of a default with homeownership may be keeping people from stepping into the housing market. This is particularly true if renters have visions in their heads of family members or friends suffering during the long and lingering foreclosure crisis.

Easy Money From Fannie Mae

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The San Francisco Chronicle quoted me in Fannie Mae Making It Easier to Spend Half Your Income on Debt. It reads in part,

Fannie Mae is making it easier for some borrowers to spend up to half of their monthly pretax income on mortgage and other debt payments. But just because they can doesn’t mean they should.

“Generally, it’s a pretty poor idea,” said Holly Gillian Kindel, an adviser with Mosaic Financial Partners. “It flies in the face of common financial wisdom and best practices.”

Fannie is a government agency that can buy or insure mortgages that meet its underwriting criteria. Effective July 29, its automated underwriting software will approve loans with debt-to-income ratios as high as 50 percent without “additional compensating factors.” The current limit is 45 percent.

Fannie has been approving borrowers with ratios between 45 and 50 percent if they had compensating factors, such as a down payment of least 20 percent and at least 12 months worth of “reserves” in bank and investment accounts. Its updated software will not require those compensating factors.

Fannie made the decision after analyzing many years of payment history on loans between 45 and 50 percent. It said the change will increase the percentage of loans it approves, but it would not say by how much.

That doesn’t mean every Fannie-backed loan can go up 50 percent. Borrowers still must have the right combination of loan-to-value ratio, credit history, reserves and other factors. In a statement, Fannie said the change is “consistent with our commitment to sustainable homeownership and with the safe and sound operation of our business.”

Before the mortgage meltdown, Fannie was approving loans with even higher debt ratios. But 50 percent of pretax income is still a lot to spend on housing and other debt.

The U.S. Census Bureau says households that spend at least 30 percent of their income on housing are “cost-burdened” and those that spend 50 percent or more are “severely cost burdened.”

The Dodd-Frank Act, designed to prevent another financial crisis, authorized the creation of a “qualified mortgage.” These mortgages can’t have certain risky features, such as interest-only payments, terms longer than 30 years or debt-to-income ratios higher than 43 percent. The Consumer Financial Protection Bureau said a 43 percent limit would “protect consumers” and “generally safeguard affordability.”

However, loans that are eligible for purchase by Fannie Mae and other government agencies are deemed qualified mortgages, even if they allow ratios higher than 43 percent. Freddie Mac, Fannie’s smaller sibling, has been backing loans with ratios up to 50 percent without compensating factors since 2011. The Federal Housing Administration approves loans with ratios up to 57 percent, said Ed Pinto of the American Enterprise Institute Center on Housing Risk.

Since 2014, lenders that make qualified mortgages can’t be sued if they go bad, so most lenders have essentially stopped making non-qualified mortgages.

Lenders are reluctant to make jumbo loans with ratios higher than 43 percent because they would not get the legal protection afforded qualified mortgages. Jumbos are loans that are too big to be purchased by Fannie and Freddie. Their limit in most parts of the Bay Area is $636,150 for one-unit homes.

Fannie’s move comes at a time when consumer debt is soaring. Credit card debt surpassed $1 trillion in December for the first time since the recession and now stands behind auto loans ($1.1 trillion) and student loans ($1.4 trillion), according to the Federal Reserve.

That’s making it harder for people to get or refinance a mortgage. In April, Fannie announced three small steps it was taking to make it easier for people with education loans to get a mortgage.

Some consumer groups are happy to see Fannie raising its debt limit to 50 percent. “I think there are enough other standards built into the Fannie Mae underwriting system where this is not going to lead to predatory loans,” said Geoff Walsh, a staff attorney with the National Consumer Law Center.

Mike Calhoun, president of the Center for Responsible Lending, said, “There are households that can afford these loans, including moderate-income households.” When they are carefully underwritten and fully documented “they can perform at that level.” He pointed out that a lot of tenants are managing to pay at least 50 percent of income on rent.

A new study from the Joint Center for Housing Studies at Harvard University noted that 10 percent of homeowners and 25.5 percent of renters are spending at least 50 percent of their income on housing.

When Fannie calculates debt-to-income ratios, it starts with the monthly payment on the new loan (including principal, interest, property tax, homeowners association dues, homeowners insurance and private mortgage insurance). Then it adds the monthly payment on credit cards (minimum payment due), auto, student and other loans and alimony.

It divides this total debt by total monthly income. It will consider a wide range of income that is stable and verifiable including wages, bonuses, commissions, pensions, investments, alimony, disability, unemployment and public assistance.

Fannie figures a creditworthy borrower with $10,000 in monthly income could spend up to $5,000 on mortgage and debt payments. Not everyone agrees.

“If you have a debt ratio that high, the last thing you should be doing is buying a house. You are stretching yourself way too thin,” said Greg McBride, chief financial analyst with Bankrate.com.

*     *     *

“If this is data-driven as Fannie says, I guess it’s OK,” said David Reiss, who teaches real estate finance at Brooklyn Law School. “People can make decisions themselves. We have these rules for the median person. A lot of immigrant families have no problem spending 60 or 70 percent (of income) on housing. They have cousins living there, they rent out a room.”

Reiss added that homeownership rates are low and expanding them “seems reasonable.” But making credit looser “will probably drive up housing prices.”

The article condensed my comments, but they do reflect the fact that the credit box is too tight and that there is room to loosen it up a bit. The Qualified Mortgage and Ability-to-Repay rules promote the 43% debt-to-income ratio because they provide good guidance for “traditional” nuclear American families.  But there are American households where multigenerational living is the norm, as is the case with many families of recent immigrants. These households may have income streams which are not reflected in the mortgage application.

Credit Card Debt and Your Mortgage

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photo by B Rosen

Realtor.com quoted me in Fannie Mae Taking a Closer Look at Applicants’ Credit Card Payments. It opens,

If you feel like you’ve been managing your debt just fine, making the minimum payment on your credit cards on time every month, you might want to change your ways before applying for a home loan.

Fannie Mae, which offers government-backed loans to more than a quarter of mortgage applicants nationwide, has just revised its risk assessment software to factor in more details about how borrowers pay off their debts.

Historically, the credit report generated by Fannie Mae—and scrutinized by lenders—mainly showed how much of your available credit you’d used and whether you’d made your monthly payments on time. But the newest version of Fannie’s Desktop Underwriter software (used by about 2,000 lenders and more than 10,000 mortgage brokers) kicks things up a notch. Now, it also details just how much you coughed up each month over the past two years—whether you’re parting with only the minimum, laying out the full monty, or hovering somewhere in between.

Fannie officials say these new details, known as “trended credit data,” can help lenders better assess how well people manage their debts—and, consequently, how well they’ll manage their mortgage payments.

“Generally, the new underwriting model gives weight to how borrowers pay off their credit debt,” explains David Reiss, research director at the Center for Urban Business Entrepreneurship at Brooklyn Law School. “While it is not clear how finely tuned the new system is, there is clearly a move toward a more granular approach to debt repayment.”

How this news affects your prospects of a home loan

So far, FICO and other credit score measures aren’t factoring in this extra info, so your score won’t get dinged. But your application could be affected in another way.

“If you compare two people with exactly the same credit profiles except that one pays more than the minimum amount due or the entire balance, that person would be considered to be a lower credit risk by Fannie Mae,” says Reiss. “As a result, that person would be more likely to be approved for a mortgage.”

But you might not have to pay much more than the minimum to boost your chances of getting that loan.“At this time it’s unclear what impact to mortgage scoring and automated underwriting the payment history will have, but we believe anyone that is paying 30% or more of their balance monthly will see improvement,” says San Diego loan officer Michael Rosenbaum at CrossCountry Mortgage.

Of course, people who pay off the whole balance every month will be favored even more, and with good reason.

“Research has indicated that borrowers who paid off their credit card debt every month are 60% less likely to become delinquent than borrowers who make only the monthly minimum payment,” Rosenbaum adds.

And while this might sound ominous, it could actually be helpful if you had some credit blemishes in your past.

“Fannie has also indicated that paying more than the minimum due will particularly help borrowers with delinquencies on their credit report, because it will allow borrowers to ‘demonstrate that a late payment was not deeply reflective of their general debt repayment ability and behavior,’” Reiss notes.

Down in ARMs

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TheStreet.com quoted me in Top 5 Lowest 7-Year ARM Rates. It opens,

U.S. mortgage rates have continued to decline in the aftermath of the Brexit vote, low Treasury rates and stagnant economy, giving potential homeowners an opportunity to save money because of the dip.

The current market conditions give homeowners in the U.S. an opportunity to take advantage of the continuation of low mortgage rates since the Federal Reserve has not increased interest rates.

But, how do you snag the absolute lowest rates, especially if you don’t plan on staying in your first home for more than seven years and are learning toward 7/1 adjustable rate mortgages (ARMs)?

The 7-year ARMs are attractive to consumers, especially first-time homebuyers, because the interest rates are lower, helping you save more money each month compared to the traditional 30-year mortgage.

“You get what amounts to a fixed rate mortgage, but at a lower rate than the traditional 30-year fixed,” said Greg McBride, chief financial analyst of Bankrate, a North Palm Beach, Fla.-based financial content company.

While lower monthly payments are appealing, the interest rates reset after seven years, and it can be difficult to determine how much they will increase.

“If your timetable changes, then you may want to reconsider the loan you have,” he said. “You don’t want to be in the position of facing rising monthly payments that squeeze your budget or jeopardize your ability to afford your own home.”

Consumers on fixed incomes and saddled with student loans and credit card debt might opt for a 30-year fixed rate mortgage, because it represents “permanent payment affordability,” McBride said. The principal and interest will never change, because it is a fixed rate and can be easier to budget.

“It may not always be the optimal choice, but it is the safest choice,” he said.

Adjustable rate mortgages can still be beneficial if homeowners take advantage of the savings each month and allocate it towards paying down debt or into an emergency fund.

“Even if you’re still holding the 7-year ARM at the end of seven years, that doesn’t automatically turn it into a bad decision,” McBride said. “You will have banked seven years of savings relative to the fixed rate mortgage that can help you absorb any payment increases until you refinance or sell the home.”

Many consumers gravitate toward the 30-year mortgage, because the payments are stable and have been very low, said Jonathan Smoke, chief economist for Realtor.com, a Santa Clara, Calif.-based real estate company. Others are seeking the 7-year ARM, because they are more likely to qualify for a mortgage.

Mortgage activity so far in 2016 reveals that only 3% of mortgages have had shorter rate terms, according to Realtor.com’s analysis of purchase mortgage activity. Hybrid term mortgages such as the 7/1 ARM typically increase in share when “mortgage rates rise because the shorter fixed term offers a lower rate, often between 40 and 100 basis points,” he said. “The lower rate translates into a lower payment for the duration of the initial term, which is seven years.”

Each lender utilizes a benchmark such as a the 10-year U.S. Treasury or LIBOR rate and a margin, which is “what is added to the benchmark to determine your new rate,” Smoke said. The loans also have a cap on how high any single rate change can be and also a ceiling on how high the rate can ever be, he said.

At the end of the seven years, homeowners can choose to refinance to a lower fixed rate, but need to budget for the closing costs.

A lower rate upfront can be favorable for younger homeowners, but examining the ceiling rate and how it will impact your monthly payments is crucial.

“A mortgage broker or lender can help you walk through scenarios to determine if your timeline could benefit,” Smoke said. “To help calm any nerves about just how high your payment could go, ask yourself if you are willing to exchange the initial seven year savings for how long you might keep that mortgage after the seven-year period is up.”

Paying the premium for the peace of mind that your payments will remain static means that if interest rates rise several percentages in the next few years, you won’t be faced with having to consider the lower rate options or lower priced homes and/or more money down, he said.

“That’s why hybrids will likely become more popular in the future compared to how little they are used today,” Smoke said.

Since people have a tendency to change homes every seven years on average, a 7/1 ARM could be a good option because the savings can be substantial, said David Reiss, a law professor at Brooklyn Law School in N.Y.

“Even if you are not planning to move now, the future may bring changes such as divorce, frail relatives, job loss or new job opportunities,” he said. “Some people like the certainty of the 30-year fixed rate mortgages, but it is worth calculating just how much that certainty will cost you.”

Caveat Rent-to-Own

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keys-1317391_1920WiseBread quoted me in 5 Things You Need to Know When Renting-to-Own a Home. It opens,

Your credit scores are too low. Or maybe you’ve run up too much credit card debt. Whatever the reason, you can’t qualify for the mortgage loan you need to buy a home. But there is hope: You can enter into a rent-to-own agreement and begin living in a home today — one that you might eventually be able to buy.

Just be careful: David Reiss, professor of law and research director for the Center for Urban Business at Brooklyn Law School, said that consumers need to be careful when entering rent-to-own arrangements. Often, these agreements end up with tenants losing money that they didn’t need to spend.

“Potential homebuyers should be very careful with rent-to-own opportunities,” Reiss said. “They have a long history of burning buyers. Does the law in your state provide any protection to a rent-to-own buyer who falls behind on payments? Could you end up losing everything that you had paid toward the purchase if you lose your job?”

These worries, and others, are why you need to do your research before signing a rent-to-own agreement. And it’s why you need to know these five key facts before agreeing to any rent-to-own contract.

1. How Do Monthly Rent and Final Selling Price Relate?

In a rent-to-own arrangement, you might pay a bit more in rent each month to the owner of a home. These extra dollars go toward reducing a final sales price for the home that you and the owner agree upon before you start renting.

Then, after a set number of years pass — usually anywhere from one to five — you’ll have the option to purchase the home, with the sales price lowered by however much extra money you paid along with your monthly rent checks. Not all companies that offer rent-to-own homes work this way. Some don’t ask for more money from tenants each month, and don’t apply any rental money toward lowering the eventual sales price of the home.

This latter option might be the better choice for you if you’re not certain that you’ll be able to qualify for a mortgage even after the rental period ends.

“A pitfall is if the tenant buyer signs into the program but will never be approved for financing, thus never purchases the house,” said John Matthews, president of operations of Chicago Lease to Own. “That is how the scammers out there have used rent-to-own to hurt people. They sell it to those who should never have been in the program and take their portion of the rent every month used ‘for the purchase of their home’ knowing that the tenant will never qualify to buy the home.”

Make sure you know — and are comfortable with — the home’s final sales price and monthly rent payments before you agree to a rent-to-own arrangement. And if you don’t want to pay extra in rent each month for a home that you might never end up buying? A rent-to-own agreement might not be for you.

Millennials and Homeownership

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TheStreet.com quoted me in Millennials Are Accruing Less Debt, Bypassing Homeownership. It reads, in part,

Millennials are accruing less debt than their counterparts did back in 2003 — despite being saddled with large amounts of student loans — because they are putting off buying homes.

The research conducted by Torsten Sløk, a Deutsche Bank international economist, shows that Millennials, ages 25 to 35, attained less debt in 2015 than their counterparts did in 2003. The data demonstrates a 29-year old in 2003 had an average debt amount of $41,761 compared to $36,810 in 2015 or a 33-year old owed $56,859 in 2003 and $52,640 in 2015.

“It is an urban myth that the young generation today is more indebted, it is the older generations that have higher debt levels,” said Sløk in a research note. “The reason is that since 2009, it has been difficult for Millennials to get a loan. As a result, 25 to 35 year olds today have less debt than in 2003.”

Debt has been “harder to obtain” for Gen Y-ers whether they are credit cards or mortgages, said Jim Triggs, a senior vice president of counseling and support of Money Management International, a Sugar Land, Texas-based non-profit debt counseling organization.

“Millennials have not been inundated with easy to obtain credit cards like in past years,” he said. “Creditors are not on college campuses offering credit cards to college students any longer.”

While Millennials are saddled with record levels of student loans because of the skyrocketing costs of college tuition and the ease of obtaining these loans, Millennials “continue to have less credit card and mortgage debt than their parents and grandparents,” Triggs said.

The level of student loan debt is hindering borrowers ages 18 to 35 from paying for necessities such as rent, utilities and even food as 43% expressed this sentiment, according to the National Foundation for Credit Counseling’s 2016 consumer financial literacy survey, said Bruce McClary, a spokesman for the Washington, D.C.-based national non-profit organization.

“There is a staggering amount of student loan debt and it is a burden for many,” he said.

Homeownership Delays

Although Millennials have expressed the desire the own a home in the future, they are keen to keep renting in part because many of them switch jobs frequently, have not amassed a down payment or do not want the financial commitment. The zeal to pursue the “American dream” of owning a home has waned.

*     *     *

The assumption that home values would rise faster than other investments has been challenged since the Great Recession, said David Reiss, a law professor at Brooklyn Law School.

“One big issue is the role that home ownership plays in wealth creation,” he said. “The bottom line is that homeownership can help build a nest egg for retirement, but long-term trends and individual decisions about homeownership will have a big impact as well.”

Tax Refunds Into Mortgage Payments

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TheStreet.com quoted me in Investing Your Tax Refund Instead of Spending It Boosts Retirement Savings. It opens,

Ramping up your emergency cash fund or IRA with your tax refund is a better option than spending it on a new smartphone or vacation.

Three out of four taxpayers received a refund of $3,000 in 2015. Although many consumers look forward to this windfall each year, it is not a “cause for celebration,” said Joe Jennings, a wealth director for PNC, a Pittsburgh-based financial institution.

“If you are receiving a large refund check, it actually means that you have loaned money to the government throughout the year and the next year the government is paying you back without interest,” he said.

Adjusting your withholdings is a good strategy if your refund exceeds $1,000. Changing the number of exemptions on your W-4 means you will net more income from each paycheck.

Bankrate.com, a North Palm Beach, Fla.-based financial content company, found that 31% of Americans who receive a tax refund this year plan to save or invest it. The survey revealed that 28% will use the funds to pay down debt, 27% will spend it on necessities like food/utility bills and 6% will splurge with a shopping spree or vacation.

Some consumers view the refund as a method of forcing them to save money each year or a way to pay down existing debt such as credit card balances with high interest.

Pay Off Existing Debt

Use your refund check to pay off as much as your credit card or student loan debt as possible since the amount of interest you are paying each month adds up quickly, said Jonathan Bochese, director of resolution services for Tax Defense Network, LLC, a Jacksonville, Fla.-based tax resolution company.

“The best use for any tax refund is to use it to pay off high interest revolving debts,” he said.

With the current low interest rate environment in money market funds and CDs, paying down debt is a no-brainer.

“If you can only make 3% on your investment and your debt is at a higher rate, pay off the debt,” said Carl Sera, a portfolio manager with Covestor, the online investing marketplace and managing principal of Sera Capital Management, a registered investment advisor in Annapolis, Md. “Don’t make it a habit to receive a tax refund, because it is money you have lent the taxing authority at a zero interest rate.”

Homeowners who do not have any other debt should pay down their mortgage by making an extra payment or two instead of stashing the refund in a savings account that is only receiving minimal interest, said David Reiss, a law professor at Brooklyn Law School.

“By doing so, you are making the equivalent of a pre-tax return of the interest rate on your mortgage,” he said. “If your mortgage has a 5% interest rate and your savings account has a 0.1% interest rate that is like getting a 4.9% higher rate of interest without taking any risk at all.”