Early Loan Payoff Gains Popularity : Home Buyers Save Money by Using 15-Year and ‘Biweekly’ Mortgages
If men could foresee the future, they would still behave as they do now.
-- Russian proverb
Maybe. Maybe not.
In the mundane world of consumerism, a mountain of evidence has suddenly arisen suggesting that today’s American--perhaps for the first time in memory--has taken a look at the future and in one respect is sharply modifying his behavior on the basis of what he sees or thinks he sees, there.
A buying pattern--so firmly in place as recently as a year ago as to be considered engraved in stone--has so dramatically shifted that it leaves experts in the field confounded by its meaning.
Gone is the “of course” acceptance of the 30-year home mortgage (“so you’re a long time building up equity, so what?”), and suddenly “in” is the desirability of paying off the home as quickly as possible. Erupting into almost overnight popularity are the 15-year mortgages and--in the roughly one dozen cities where it has been made available--the so-called “biweekly” mortgage.
“I’d like to think,” one Midwestern lender said, cynically, “that home buyers have suddenly gotten smart--that they’ve looked at those figures and realized how much interest they’re paying out over 30 years. God knows they’ve been dumb about it long enough.”
‘Fear of the Future’
But while disillusionment about a future of endless mortgage payments with little to show for it during most of the life of the loan is undoubtedly a part of the swing, John Blackburn, a professor of finance and law at UCLA, sees another possible explanation.
“I think that everybody, the lender as well as the home buyer, is a little bit fearful of the future--about the economy, the possibility of new inflationary cycles, and even the fate of the dollar itself.”
Whether it’s a new appreciation of the future, or a fear of it, however, the rush toward fast payoff is a phenomenon of 1985.
In all of 1984, for instance, Fannie Mae (the Federal National Mortgage Assn.), one of the two major marketers of home mortgages, bought only $232 million in 15-year mortgages--a negligible factor in the billions of 30-year mortgages it bought in the secondary market the same year. So far in 1985, however, spokesman David Jeffers said, 15-year mortgages account for no less than $2.4 billion of Fannie Mae’s $35 billion in commitments--one in every seven mortgages bought and subsequently resold to investors.
At Freddie Mac (Federal Home Loan Mortgage Corp.), the swing is even more dramatic, according to spokeswoman Jean Ryan. With almost $4 billion in 15-year mortgage commitments made this year, the figure represents one in four of that agency’s purchases.
More Auction Activity
“When we started buying and selling 15-year Mortgage Participation Certificates in mid-84,” Ryan added, “there were so few of them that--unlike 30-year PCs which are auctioned off daily--we auctioned off the 15-year mortgage PCs about once every two months as we accumulated enough of them. As the volume increased, we went to weekly auctions and, finally, as of Oct. 7, we went to daily auctions. Investors really love them.”
It’s a pattern of sudden, almost explosive, acceptance of the 15-year fixed-rate mortgage that is repeated with the Mortgage Bankers Assn., too, where from “minimal attention” just a year ago, according Robert J. Spiller, the association’s immediate past president, the accelerated mortgage now accounts, again, for about one in seven mortgages written.
“The move to early-payoff mortgages,” Spiller added, “suggests growing consumer sophistication regarding home loans. Those home buyers who see retirement down the road, or face substantial outlays for children’s college education, often choose early-payoff loans, we’ve found.”
Tilted Toward Lender
While the common sense economics of an accelerated payoff has always been given lip-service by lenders, even the seasoned second and third-time home buyer--and, certainly, the first-time home buyer--loses sight of how heavily the standard, 30-year, fixed-rate mortgage is tilted in the lender’s favor:
--That, during the first month of a $100,000 mortgage (at 13% and calling for monthly principal and interest payments of $1,106.20), only about $22.09 of that payment goes to principal and creation of equity.
--That, during the first year of the same mortgage, only about $290.07 of the total payments of $13,274 have gone toward principal.
--That it is normally in the 24th or 25th year of a 30-year mortgage before the home buyer’s monthly payment of $1,106.20 splits 50/50 between interest and principal.
--That, at the end of 30 years, that $100,000 mortgage has cost the home buyer a grand total of $398,232--a mind-boggling $298,232 of it in interest.
--That, by cutting the same mortgage down to 15 from 30 years (and raising the monthly payments from $1,106.20 to $1,265.25), the total cost to the home buyer is $227,745 for a net savings in interest of $170,487.
Loan Qualifications
“While you certainly can’t quarrel with the arithmetic of the 15-year mortgage--and the sudden popularity of it--I think, it is largely representative of fears about the future and fears about the dollar--there are limits on how far the trend can go,” according to Fred E. Case of UCLA’s Graduate School of Management. “Not everybody who sees the sense of the 15-year mortgage is in a position to qualify for one.”
And qualifying for any mortgage--the acceptable ratio of monthly payments for principal and interest as a percentage of monthly income--is largely determined by the requirements laid down by Fannie Mae. The organization, its spokesman Jeffers said, tightened its requirements Oct. 15 for home buyers taking on mortgages with a 10% or less down payment. Principal and interest on these mortgages cannot exceed 25% of the buyer’s monthly gross income (33% of net after other installment payments), but remains at 28% for buyers paying more than 10% down.
Thus, in the case of a $100,000 mortgage financed for 30 years at 13%--calling for monthly payments of $1,106--a buyer who has made a down payment of more than 10%--must have a monthly gross income of at least $3,948 ($47,376 annually) to meet the 28% guideline.
Taking on the same mortgage at 12% (a rate reflecting lenders’ preference for shorter-maturity mortgages), but for 15 years instead of 30, would increase the monthly payment for principal and interest to $1,200. But it would also require a monthly gross income of at least $4,284 ($51,408 annually) to qualify--which, Case noted, would rule out “quite a few marginal buyers who might otherwise be interested in the 15-year mortgage.”
Limited Availability
And here, since it is amortized, and payments are based on a 30-year payoff--despite its actual payoff in about 18 1/2 years--is where the newly popular “biweekly” mortgage comes into the picture. Also known as the “Canadian,” the “pay-day,” or the “rapid amortization” mortgage, the home financing plan has been used for only about 18 months in the United States and is available--by best estimates--in only about a dozen cities so far.
“I read about it when I was up in Canada,” according to Robert Montgomery, president of City Savings Bank in Meriden, Conn., (pop. 57,000), which is generally credited with being the first institution to introduce the plan in this country. The mortgage was devised by Canadian credit unions for their members who were paid biweekly and was particularly popular north of the border since mortgage interest payments in Canada are not tax deductible.
“We brought it out in May, 1984,” Montgomery said, “And we’d no sooner launched it than I got snowed under by letters from more than 550 banks and savings institutions around the country wanting to know more about it. That’s been the experience of everyone who’s gone into the biweekly--they get swamped. And I’ll have to say that it’s the first time in my life that I’ve run across a product that’s as good for the consumer as it is the lender.”
So much in demand has the biweekly mortgage been in Meriden, Montgomery said, that it now constitutes the only mortgage program that City Savings offers--and all of them written as adjustable rate mortgages (at 10%) after a 20% down payment and with a 1%-a-year cap.
‘Difficult to Explain’
Probably the biggest challenge in introducing a biweekly mortgage plan, according to the father and son team of R. H. and Stephen Harry, president and vice president, respectively, of Oklahoma City-based Harry Mortgage Co., which brought out its “Rapid Amortizing Mortgage” a few months ago, “is that it’s definitely difficult to explain. They want to know: ‘what’s the catch?’ ” Stephen Harry said. “There have been so many different financing plans introduced the last couple of years that you can hardly blame them.”
And the key ingredient of the biweekly mortgage is as confounding on the surface as it is simple: Instead of paying your regular (30-year amortized) monthly payment once a month, you pay half of it biweekly. The result: The house is free and clear in 18 1/2 to 18.96 years (depending on the interest rate) instead of 30. What’s the catch?
The “catch” lies in two features built into the mortgages:
--While each payment is, indeed, just half the normal monthly payment it is made “biweekly,” (every other week) not “semi-monthly,” which means that two extra payments are being made every calendar year (26 in all).
--An accelerated reduction of the principal is being made every 14 days, not once a month.
Cutting the Principal
“A lot of people say you can accomplish the same thing without so much bother simply by making one extra monthly payment once a year,” Stephen Harry added. “But that extra monthly payment each year isn’t really what gives the RAM its impact--it’s the cutting down of principal that begins 14 days after you’ve taken out the mortgage that does it.”
Consider a $50,000, 12%, mortgage financed both ways: through a conventional 30-year mortgage, and through the Harrys’ RAM:
“Under the conventional mortgage,” R. H. Harry said, “your payments would be $514.31 a month, it would be paid off in 360 months and you would have paid $135,132.82 in interest.
“But, under the RAM program, you would pay $257.16 biweekly, the loan would be paid off in 224 months, 18.8 years, and you would have paid $75,928.17 in interest.”
The eye-opener, however, is in the fast establishment of equity in the home.
Makes Comparison
“On the conventional $50,000 mortgage,” Harry continued, “you would still owe $49,834.48 on it after the first year--not too much difference from what is owed after the first year on the biweekly mortgage, $49,311.97. But, after five years, there’s $48,857 still owed on the conventional mortgage and $45,276 on the biweekly. After 10 years, the conventional mortgage still has a principal due of $46,754 versus $36,601 on the biweekly. And, after 15 years, the principal still due on the biweekly, $20,687, is less than half the principal still owing on the conventional mortgage, $42,935.”
And, after 18.8 years, the biweekly mortgage is paid off in full while the conventional mortgage still has $38,269 still owing on it.
For any biweekly mortgage plan to work, Harry added, one element is an absolute “must”: the electronic transfer of funds--the automatic debiting of the biweekly payments from the home buyer’s checking or savings account.
“That’s absolutely essential,” he said, emphatically, “otherwise the paper work would be horrendous. If a home buyer has always paid with coupon books by check, and can’t change his ways, then he’s not for us.”
No Secondary Market
The other hang-up from the lender’s standpoint was pointed out by Penny Cavanaugh, vice president of secondary markets for Phoenix’s First Federal Savings & Loan Assn.--with assets of about $4.5 billion the largest lender yet to enter the new field of the biweekly mortgage.
“Unlike the 15-year mortgage,” she said, “there’s no formal secondary market for the biweekly mortgage. Neither Fannie Mae nor Freddie Mac is yet geared up to buy them. It hasn’t stopped us though, because there are a lot of people out there--private, institutional investors--who are more than willing to buy them, but aren’t in a position yet themselves to go into the field.
“We’ve had a biweekly mortgage advertising campaign on the books for some time,” Cavanaugh said, “but we simply haven’t had to use it yet--the word simply got out. Now, for every five applicants we get for the shorter mortgage, four of them are going for the biweekly, and only one is taking the standard 15-year mortgage.”
Where’s the market for the biweekly mortgage?
“One thing you’ve got to realize about Meriden, Conn.,” City Savings’ Montgomery said, “is that it’s a blue-collar town. This is a place where you buy a house to live in for the rest of your life.
Workers Liked It
“We knew that we wouldn’t have any trouble explaining it to the yuppies (young urban professionals) because they’re investment-oriented, anyway, and we knew they’d see the advantages right away. But the blue-collar workers turned out to be every bit as receptive because they’re budget-minded and everything revolves around their paycheck--which almost all of them get either weekly or biweekly.”
It’s a pattern that the Harrys’ RAM program in Oklahoma and Tulsa also reflects, “although about 90% or more of our volume so far has been in refinancing--by second- or third-time home buyers,” Stephen Harry explains. “We’ve even had a few people coming in with lower fixed-interest rates and taking on a biweekly at a higher rate.
“We had one the other day trading in an 11% fixed rate for our 12% biweekly. When I asked him ‘why?’ he said: ‘I’ve got another 28 years to go at 11%, I’d much rather have a 12% for a little over 18 years.”
Essentially, the Harrys have found, their biweekly market falls into four categories:
--Customers who don’t like adjustable rate mortgages and want a shorter-term fixed rate;
--Middle-aged buyers on their second or third home and looking at retirement in 18 to 20 years, or conversely, younger buyers looking ahead to college expenses looming up in about 18 years;
--Sophisticated buyers who are aware of the interest they’re paying and, even though they may be planning to move in three to five years, want the fast equity build-up of the biweekly mortgage, and
--The budget-conscious buyer mentioned earlier who finds two $600 payments easier to build his budget around than one big $1,200 payment.
Like the pioneer biweekly lender, City Savings in Connecticut, California’s only currently active entry in the field, San Jose’s First Franklin Financial, also specializes exclusively in the adjustable biweekly mortgage.
“We had a tremendous response when we came out with the biweekly this past February,” First Franklin’s president, Bill Dallas, said, “and we were writing them at the rate of $3 million to $4 million a month, although when fixed rates dropped below 12% we lost a little momentum.
“We’re getting a fair share of first-time home buyers, though, because with the adjustable feature--starting at 9 3/4% or 10%, with an annual 2% cap, a 15 3/4% lifetime cap, and no negative amortization--we’ve stayed pretty competitive.”
Without exception, all lenders active in the biweekly mortgage market interviewed for this article concur that as soon as either Fannie Mae or Freddie Mac gears up to buy biweekly mortgages in the secondary market, the field, in the words of one lender, “will bust wide open. The 30-year mortgage is a dinosaur.”
Or, as City Savings’ Montgomery put it: “The beauty of the biweekly is not only that I get my money back fast and can lend it out again, but with the electronic transfer, most of the overhead and the trouble for both consumer and the lender is taken care of--there are no checks to be written, no coupon books, no postage and no late payments. If the whole country went this way, we’d have more money for housing than you can shake a stick at.”
