3 ms·

It is technically true that the terms don't change when the house value changes, but it is misleading to suggest that house value doesn't affect affordability.

by lacker 18y ago

It is technically true that the terms don't change when the house value changes, but it is misleading to suggest that house value doesn't affect affordability. The distinguishing feature of most subprime loans is that the interest rate changes after a few years. A typical subprime loan could be 3 years at 8%, then 27 years at 12%. The assumption (made by bankers to justify the subprime model) was that after paying lower prices for a few years, the borrower would have some equity built up in the house, so they would be a better credit risk, and they could refinance at that point for a lower rate. But, when housing prices dropped, many of these houses were now worth less than the outstanding amount on the mortgage, even after a few years of paying down the loan. So the plan of refinancing after a few years didn't work any more. Basically, it is easier to afford a house if it maintains its value after you buy it, because the equity gives you more flexibility in refinancing. Sorry if this is too boring ;-) But if you are curious to read more about the particular characteristics of subprime mortgages I recommend this paper - http://www.kc.frb.org/publicat/sympos/2008/Gorton.08.04.08.pdf http://www.kc.frb.org/publicat/sympos/2008/Gorton.08.04.08.p...

anamax 18y ago
> The assumption (made by bankers to justify the subprime model) was that after paying lower prices for a few years, the borrower would have some equity built up in the house, so they would be a better credit risk, and they could refinance at that point for a lower rate. No, that's not what happened. Folks got loans where they could afford the teaser rate but not the regular rate. Even if they'd put down 20% and the house didn't go down in value, they couldn't afford what they'd bought. If housing prices had continued to appreciate, they could have done a cash-out refinance and used that money to help them pay for the new loan, but that just delays the inevitable. ($50k doesn't go very far when a payment that you can't afford goes up by $1k/month.) Or, they could have sold and taken the equity to buy something that they could afford. The only way that they could have kept those houses (without significantly increasing their income) is if they'd been able to do no-cost refis with teaser rates until they were paid off. Since many/most of those loans were interest-only.... Note that most of the teaser-rate loans had prepayment penalties. The amount of equity that one has in a house has very little effect on the interest rate. The big driver is interest rates in general.
anamax 18y ago
> But, when housing prices dropped, many of these houses were now worth less than the outstanding amount on the mortgage, even after a few years of paying down the loan. If you look at the loan amortization table for a 30 year fixed loan, you'll see that there's very little pay-down in the first several years. There's zero pay-down with interest-only loans, which many of the teaser-programs were. There's NEGATIVE pay-down with interest-deferred loans (which many of the teaser-programs were). > Basically, it is easier to afford a house if it maintains its value after you buy it, because the equity gives you more flexibility in refinancing. Refinancing makes a house more affordable only if interest rates decline, and then only if you don't take money out.

by lacker 18y ago

anamax 18y ago

> The assumption (made by bankers to justify the subprime model) was that after paying lower prices for a few years, the borrower would have some equity built up in the house, so they would be a better credit risk, and they could refinance at that point for a lower rate. No, that's not what happened. Folks got loans where they could afford the teaser rate but not the regular rate. Even if they'd put down 20% and the house didn't go down in value, they couldn't afford what they'd bought. If housing prices had continued to appreciate, they could have done a cash-out refinance and used that money to help them pay for the new loan, but that just delays the inevitable. ($50k doesn't go very far when a payment that you can't afford goes up by $1k/month.) Or, they could have sold and taken the equity to buy something that they could afford. The only way that they could have kept those houses (without significantly increasing their income) is if they'd been able to do no-cost refis with teaser rates until they were paid off. Since many/most of those loans were interest-only.... Note that most of the teaser-rate loans had prepayment penalties. The amount of equity that one has in a house has very little effect on the interest rate. The big driver is interest rates in general.

anamax 18y ago

> But, when housing prices dropped, many of these houses were now worth less than the outstanding amount on the mortgage, even after a few years of paying down the loan. If you look at the loan amortization table for a 30 year fixed loan, you'll see that there's very little pay-down in the first several years. There's zero pay-down with interest-only loans, which many of the teaser-programs were. There's NEGATIVE pay-down with interest-deferred loans (which many of the teaser-programs were). > Basically, it is easier to afford a house if it maintains its value after you buy it, because the equity gives you more flexibility in refinancing. Refinancing makes a house more affordable only if interest rates decline, and then only if you don't take money out.