Both Oars In Affordable, But Safe

Aug 13, 2010

The Fox News gang has their undergarments in a bunch again. This time it is over the Fannie Mae-backed pilot mortgage program called Affordable Advantage, which allows a prospective home buyer to secure a 30-year mortgage at market rates with a minimum down payment of only $1,000. Qualifications also include having a 680 plus credit score and a strong work history. There is reason for caution here; however, with a few adjustments, this program could be made safer and more palatable for tax payers who are already on the hook through Fannie Mae and Freddie Mac for billions in mortgages.

But before we delve into the details of how to improve the quality of affordable mortgages, I have a bit more to say about Fox News and undergarments. While watching Fox and Friends in order to follow up on the Affordable Advantage hoopla, I was disappointed to witness the morning team’s juvenile interview on bra design with three Victoria’s Secret models, complete with the company’s trademark, line-blurring ads. Fox would get lampooned a little less if they avoided this overt spicing of the news. I was especially offended when the song “Calling all Angels” was used as the background music to their wait-for-it entrance. 

Back to mortgages: The primary complaint about the Affordable Advantage program is that it is basically a 100% mortgage. This is a valid concern. There is no doubt that allowing little or no money down was a major culprit in letting people into mortgages beyond their budget, inviting highly leveraged speculation on real estate by ordinary people and making it easier for people to walk away from their mortgages when the market turned. In hindsight, the removal of the ‘20% down’ requirement is appropriately seen as the first and most significant step down the slippery slope that eventually led to the current mortgage crisis.

Limiting the term to 15 years may answer this concern without creating an insurmountable barrier for buyers who do not have much savings, which includes a lot of young people with good jobs. By changing the loan duration to 15 years, buyers would accrue equity more than two times faster than they would with a 30 year mortgage. At just over four years into the loan, assuming no change in the value of the property, the buyer would have 20% equity in the house. Add the stipulation that the homeowner cannot take a second mortgage or home equity loan without refinancing the first mortgage, and you may have the same positive effect on the quality of the mortgage pool as you would by keeping the requirement for 20% down.

There is a second advantage of changing the amortization to 15 years - the monthly payments would be higher. The artificially low monthly payments created by Adjustable Rate Mortgages and terms 30 years and longer during the last decade enticed people to leave modest homes in which they had substantial equity and stretch for dream houses they ultimately could not afford. Others jumped into the market solely based on the hope for rapid appreciation. The market said, “Buy more; make more.” This caused a frenzy of real estate activity that inadvertently created a Ponzi scam and drained equity from the market. Higher monthly payments would keep the market saner.  

To strengthen the admirable credit score requirement, buyers should also have to meet the oft ignored debt-to-income ratio [DTI] of 36%. Cumulative personal debt—car, house, college and credit cards—should not be allowed to exceed 36% of a person or couple’s income. This rule must be strictly applied and must only take into consideration verifiable income. No soft numbers on the income side or hidden ones on the debt side.

There also must be an assurance that we have entered a zero tolerance period for fudging or massaging numbers. To make this clear, I suggest a new symbol be created, similar to the yuck face applied to harmful-if-swallowed household chemicals or the black and red symbol used for hazardous waste, to be applied to the closing documents for Affordable Advantage loans with the warning: Fraud on the part of any party, not limited to but including the misrepresentation of appraisal values, borrower’s income or debt, will result in prosecution of all those involved. The symbol could be an image of a real estate agent, mortgage broker and buyer in a jail cell.

Given the combined importance of the construction, banking and real estate sectors to the health of our economy, it is in everyone’s interest to support programs which can stimulate recovery in the residential housing market. On the other hand, it is also in our interest to make sure the programs are safe for the buyer and the backer, which is all of us at the present. However, making this happen will require a bit more pressure on Washington than a few wry comments between lingerie segments.