New Equity-Building Mortgage Works for Some

A new so-called wealth-building home loan is gaining traction among low- and moderate-income borrowers as a tool to build equity fast, reports Los Angeles Times in a recent article

The key feature of the loan, unveiled in September 2014, is a sharply reduced interest rate on a 15-year term.

“Instead of requiring a down payment, banks allow borrowers to use their money to pay interest upfront, often called ‘buying down’ the rate,” Los Angeles Times says.

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Borrowers seeking to buy a modestly priced home cannot own any other property and are required to live in the one- to four-unit properties that they purchase.

Grace and Armando Ong, of Southern California, lost their home during the housing crisis, and recently applied for the new loan.

“For their $400,000 house, the Ongs used what would have been a 4% down payment — $16,000 — to instead buy down their rate to 0.5%,” Los Angeles Times says. “In little more than three years of monthly payments, the couple will have more than 20% equity in the home, assuming the property value stays the same.”

The new loan can benefit banks as well as home buyers as well.

“In a [Neighborhood Assistance Corp. of America] NACA program, for example, Bank of America and Citibank chip in subsidies to fulfill their obligations under the 1977 Community Reinvestment Act to provide affordable funding to modest- and low-income borrowers,” Los Angeles Times says. “The banks have put a total of $13 billion into a program to offer discounted mortgage rates, now including 15-year as well as 30-year loans. Citibank offered the Ongs, who were NACA clients, the $400,000 wealth-builder loan at 2.5% and allowed them to buy down the rate.”

Bruce Marks of NACA joins Edward J. Pinto and UCLA researcher Stephen D. Oliner, resident fellows at the conservative-leaning American Enterprise Institute, in support of the new loan.

Loan advocates tell Los Angeles Times they are having discussions with about 20 institutions — lenders, insurers, investment firms, nonprofits — to make the discounted 15-year loans widely available to borrowers of all income levels.

Read the article here.

Written by Cassandra Dowell

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  • Just the interest and principal portion of the Ongs’ monthly mortgage payment calculate to $2,307. The Ongs conjure up the picture of a senior with little cash for a down payment but they do not conjure up the picture of a low-income buyer since they are looking at increasing their monthly payments of interest and principal to almost $5,000 so that they can pay off the loan in just 7 years rather than 15.

    If the Ongs had used the $16,000 as a down payment, the interest and principal portion of their monthly mortgage payment would have been $2,560. Based on a 2.5% interest rate, the difference in house payments over 180 months is $45,540. Yet there is no basic difference in what it cost to get the home. It is all in how the $16,000 was applied and how generous this program can be in lowering interest costs for participating borrowers when done correctly.

    The Ongs are looking to pay off the mortgage in just seven years. The question is why? Doing that will push the principal and interest payment alone up to $4,847 per month. Someone needs to talk to the Ongs. The Ongs have such a low interest loan and cash is hard to obtain when you need it. They would save a little over $8,100 in total payments by shortening the fixed payment payoff period to seven years which is a relative low price to pay for substantial cash of your own.

    If the Ongs, paid down the loan at the minimum amount required and took out a HECM when Mrs. Ong was 62 (five years from now), their balance due would be $270,000; they would have saved up over $152,400 by not making a higher mortgage payment than required meaning they could pay down the amount due on the HECM at initial funding to around $123,000 including closing costs (assuming the appraised value of the home in 2020 is around $450,000). This would mean they could pay down the remainder of the balance due on their HECM as they see fit and still have a line of credit of about $100,000 and more especially if they are actively and aggressively paying down the HECM.

    Yes, the accruing costs on the HECM would be much greater than the 0.5% they were paying and the upfront HECM costs would be about $6,000 assuming no origination fee, but they had access to substantial cash after the first six months or so and using up all of their savings on the difference between the maximum mortgage payments they could have made and the minimum they did, they have a ready but growing line of credit of over $100,000.

    Even seniors who have little money for a down payment should look into the NACA program; however, as a fifteen year mortgage the house payments are not low.

    • I try to do these types of scenarios for my purchase clients but I really like how you approach this. In my opinion it really does show how cash flow is so important and completely misunderstood by realtors and some financial planners.

      • wealthone,

        Income planning and cash flow planning are like the most common type of Venn diagram, each being a separate circle. In this case, the circumference of each circle only intersects at two points so that part of each circle is inside of the other and part is not. If you see little of (or do not see) the areas which are outside of the other circle, you generally communicate as if cash flow and income are all but indistinguishable. Many unfamiliar with the concepts expressed in a Venn diagram may see the two circles as one figure without recognizing it is really two figures of which at least one point is shared in common. So it is with many who have difficulty recognizing which part of cash flow is inside of the income circle and which is outside; they also have difficulty classifying which is which and find little wrong with misclassifying them.

        We also see the Venn diagram concept showing up when looking at 1) taxable income for federal income tax purposes and 2) cash flow for that same tax year. While the income tax return shows specific types and portions of cash flow as taxable income (the area in common), not all cash flow is taxable (the area of the cash flow circle which has nothing in common with the taxable income circle), and some things which are not cash flow in that tax year may be taxable (the area of the taxable income circle which is outside of the cash flow circle). Rarely will the two be one since many taxpayers receive such nontaxable items as 1) birthday and other presents in the form of cash or cash equivalents and 2) cash advances from their credit cards.

        So why is the cash flow area which has nothing in common with income so important? Cash flow can increase because a cost like gasoline goes down. That reduction is NOT an increase of income to consumers but it increases cash flow for American consumers due to lower costs from 1) the direct price of gasoline at the pump and 2) as price reductions to other costs due to lower fuel costs. If all cash flow was freely interchangeable with income meaning they are the same, then the decrease in gasoline prices would not increase either income or cash flow.

        In law and the legal aspects of accounting there is a huge difference between cash flow and income. For example, in order to pump up the net income of Enron, executives at Arthur Andersen and Enron colluded in showing debt proceeds as both cash inflow and revenues on the consolidated (and combined) financial statements of Enron. The Enron executives mandated this fraud so as to entice investors to trade up the price of the Enron stock. As to our industry some smart and aggressive prosecutors could make the argument that seniors were deceived into getting a HECM because they were told that it was income and at the same time not taxable even though those involved in pitching the HECM had no intention of deceiving the senior.

        So what is the most significant problem with misclassifying debt proceeds as income? Labeling debt proceeds as Income does not imply required repayment of the amount of the cash flow, while labeling that amount as debt proceeds does. Income is an integral part of any statement of operations (and thus net income) while debt (other than an amount forgiven by a lender) does not.

        By keeping the concepts of income and cash flow separate (where they are separate) illustrations of why a HECM can be an important financial tool in retirement can become clear and apparent particularly to the more financially affluent, astute, and sophisticated.

        So, like you, I compliment The_Cynic for providing such a clear illustration of the value of cash flow particularly in combining it with the use of an adjustable rate HECM as both a cash flow tool and an open end mortgage.

      • wealthone,

        Not only is there the need for articles showing how HECMs can improve and extend cash flow but also demonstrating how cash flow access and money management can be improved through debt management and integrating the use of a HECM in that presentation.

        I am afraid contingency planning is under appreciated by most financial professionals. Realtors are among the worst and I have been a real estate broker for over twenty years.

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