The Freddy's Mortgage Proposal
I've been thinking about home mortgage loans recently. No problems on this end. Actually good things, but I got to thinking back and realizing how screwed up mortgages are. They're entirely front loaded with interest.
I recall looking at our mortgage statement probably 20 years or more ago. I'd been told about it before but it really brought it home when I noticed how it worked. Of the $650, more or less, that we paid each month, only $50.00 went towards the principal. All the rest was interest paid up front. I didn't think that was right then and still don't.
To be fair, as the years went by, the proportion of principal paid to interest increased, so it does get better over time.
I know some of you will say, "but, Freddy. How can a libertarian propose telling a private bank what to do?". That might seem like a good question but we all know banks and the government are joined at the hip, and perhaps for good reason. Since the government sets the banking rules, they should be able to make mortgages work better.
I propose mortgage payments be allocated at least 50/50 from the start. When you make a payment, 50 percent of it goes to interest, 50 percent towards principal. No, the banks aren't going to make out as well, but they'll still make a fair amount of money. This would allow homeowners to take full possession of their home much earlier. Maybe even in half the time or less than they do now.
Think of the extra money they'd have to spend on everything else. With most people's biggest monthly expense being a mortgage (or rent), if you pay it off in half the time you'd have all that money to use for many other things. Might actually boost the economy.
I'm sure there could be some downsides. It could be inflationary. The banks will likely be complaining, but they'll survive as they nearly always have. I'm all eyes and ears if anyone wants to suggest this wouldn't be a good idea and, no, I'm not expecting congress to get right on it.
posted by Fred Mangels @ 7:51 AM
9 comments
9 Comments:
People take out 30 year mortgages to lower their payments to something affordable. What your proposing would jack their payments up to something they couldn't afford.
I've heard that you pay something like 3 times the value of the home by the time you pay off a mortgage. So, a $100k house costs $300k or more when you're done. I wonder if it wouldn't be cheaper if more of the principal was paid off earlier? Then it might be affordable.
I'm not sure. It would probably take a CPA to crunch the numbers and come up with a workable plan. Still, it just seems wrong the banks pretty much get their predetermined interest up front.
If you could set up some kind of fund from which borrowers could receive enough to lower their payments to something reasonable, you'd really have something.
"If you could set up some kind of fund...".
I believe that's kind of what Fannie Mae and Freddie Mac do for banks, kinda. Read an explanation of that not too long ago.
The guy wrote that if a bank has a million bucks, it can only finance one million dollar home. Once they start that loan, the bank can't do any more loans since they have no money. So, Freddie and Fannie buy the mortgage from that bank. Then the bank has another million to make another loan. Something like that, anyway.
How something might work for a borrower, I have no idea. Numbers and finance are NOT my forte.
Money is just a tool. When you rent a rototiller for the weekend you pay x amount of dollars to do that. A mortgage is the same thing, you're just renting/borrowing their money for a longer time frame.
People have the option to have 50% of thier payment go to principal, just pay more. If you had paid $1200 each month instead of the minimum required $650, you would have achieved that. There are several online calculators that will show how paying an extra $50 per month will save you thousands in the long run. When I worked for a bank, I used to show people the numbers all the time, it amazed them.
The amount of interest goes down at the end because you are using less of the banks money. You have to pay for what you use. The alternative is going back to loans with pre-payment penaltys so the banks are guarenteed the revenue for the duration of the loan. People wont like that, and its not a very good option.
Also you are missing the real reason why the Banks do this front-load on interest. Most people do not stay in their home the entire 30 years. They actually sell it. I believe the average time frame is 7-10 years. They buy a bigger home. Maybe a smaller home. Because of this the banks are owed a large amount of the principal during this period, and they have done quite well with your predominant interest payments during the early periods of the loan. However what Amber said is absolutely correct. By paying more you have the ability to pay off the loan early.
I kinda accidentally paid around $1800 on our principle early some years ago. I think that's why we ended up in a pretty good position recently.
I'd been trying to make extra payments in the event something happened to me and I wasn't able to make my mortgage payments. I got up to 2 or 3 months ahead but GMAC kept putting those payments towards the principle. I called them twice but they kept putting the money against the principle within weeks after I'd called.
I finally called one last time. The guy I spoke to was a complete idiot and couldn't understand the problem. I gave up, pissed, but that also meant around $1800 less of the principal to pay off.
When banks structure mortgages so that less of the monthly payment goes to the principle in the early years of the mortgage, the result is akin to having a revolving department store account where the interest is added to the amount still owing. (I think the regulation for structuring interest over the life on the mortgage is Rule Z.)
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