Mortgages Are About Math | Hacker News Reader

Mortgages Are About Math

toddwschneider.com

32 pointspskotarczak30 comments

See also earlier discussion (16 days ago) under title Open-Source Loan-Level Analysis of Fannie and Freddie:

https://news.ycombinator.com/item?id=9685534

(The full title of the article is Mortgages Are About Math: Open-Source Loan-Level Analysis of Fannie and Freddie)

In 2008, I was house shopping. I was pre approved for a mortgage by the bank that I was using at the time.

A couple of weeks later, I found the house that I wanted and went to the bank headquarters to get started on finalizing the deal. The bank VP brought me papers that showed an interest rate that was 1% higher than the rate for which I had been pre approved, less than two weeks before.

When I pointed this out, he gave me a line about how mortgage rates fluctuate daily. I responded that I had been checking mortgage rates on bankrate every day for months and no one else's rates had increased by 1% in the last two weeks. Me paying that higher rate was simply not going to happen.

He thought I was bluffing and said "This comes out to only about $40 per month on your payment, are you really willing to not buy the house over $40?". I did the math in my head, roughly $500 per year, $5000 per decade, $15000 over 30 years. I told him "I'm buying the house. The real question is if you're willing to miss out on hundreds of thousands of dollars in interest over $40 per month?". He said that there was nothing he could do. I gathered up my documents, closed my briefcase, got up and walked out of his office.

I contacted a mortgage broker and got a new pre approval from another lender. I ended up getting a rate that was right between my original pre approved rate and the rate that S&T Bank tried to get me to take.

I think that a lot of people get overwhelmed by the jargon. Rate, points, APR, APY, closing costs, PMI, overpayment penalties and everything else that goes along with it and just want the whole process to be over. I think that a lot of people just sign the papers to be done with the process because they don't want to deal with the process anymore.

Get past the jargon and industry terms and the math isn't difficult. Additionally, it's worth it to know the numbers and what implications are attached.

I saved a lot of money using a broker.

I'm actually not sure why people go directly to banks -- brokers are there to do all the work for you and to save you money.

The key to mortgage brokers is using several. Contact two or three and see which one finds the bank with the best deal.

As a counterpoint, I'm not sure why anyone would use a broker when it is clear they also need to get paid; and you can call a dozen banks to get their interest rates for whatever kind of loan you're trying to get yourself. When you're talking about hundreds of thousands of dollars (or maybe even over a million), doing a bit of work yourself seems like a good idea.

Well, in theory the broker is getting paid by the lender, not by me (the borrower). Of course, we all know that in a rational market, that cost has to be passed on to me. And yet strangely, I get a better offer when I ask the broker than when I straight up tell the bank "I'm going to go to a broker now, and so this is your last chance to beat whatever offer they're going to give me".

Conclusion: lenders are irrational. Surprise!

I suspect that this has something to do with the fact that a portion of the administrative work is offloaded to the broker.

I never met anyone from the lender when I got my mortgage. All of the background investigation, income/employment verification and paperwork was completed with the broker.

> Get past the jargon and industry terms and the math isn't difficult.

If you are talking about the math on individual mortgages, you are quite right. It is quite literally what should be the foundation of a basic education.

If you are talking about mortgages in aggregate, as the article is, the math is surprisingly difficult. Modeling prepayment rates, default rates, etc especially as they relate to rate changes and economic inputs is surprisingly hard.

I think that this is very true. I've reflected on the trouble I've had in the past with things like applying for college, filing taxes, filing worker's compensation claims, and so on. I find it difficult and more than once I've given up on something important to me because I couldn't cope with the paperwork and process.

Right now I'm researching real estate and financial planning in my spare time, even though these aren't major concerns for me yet, simply because I want to be prepared when it's time. It's difficult stuff. It may be possible to help some people with apps or services that make the process invisible to them, but I'll never be convinced that such a shortcut isn't taking advantage of me. So for people like me, I guess there will always be a market for better books.

Anyone buying a home in 2008 wasn't doing the math. That was prime time bubblesville.

ARMs and Interest Only mortgages factored heavily into that situation.

I have a friend who lost a house during the bubble because his ARM went up when he was having financial difficulties.

I bought mine a few months before the bubble burst. Fixed rate and a reasonable (at the time) rate. Interest rates have dropped since then but I haven't taken the time to refinance.

"The inland cities, with more land available to allow expansion, experienced the most overbuilding, the most aggressive lenders, the highest levels of speculators looking to get rich quick by flipping houses, and so perhaps it’s not that surprising that when the housing market turned south, they also experienced the highest default rates."

This is a pretty strong theory: more land ==> all these things, including overbuilding. What is "overbuilding" even supposed to mean? "Over" relative to what?

These studies indicate that the problem is slow permitting and high regulation in places that do have lots of land: http://blogs.wsj.com/moneybeat/2014/02/27/why-las-vegas-got-...

Texas and Atlanta have lots of land around them, but they did not have nearly the default problem of vegas and florida and california because they built a lot very quickly, so prices never rose dramatically.

In short, there was not overbuilding. There was underbuilding, and building that happened too late.

I don't understand why everyone thinks that higher home prices are automatically good? High home prices only benefit real estate brokers, banks, local government, and a few landowners that got in early.

Very few of my peers <30 yrs old (or older) are able to afford homes.

Rising prices seem good superficially because a lot of people own houses and that means everyone is getting rich! The harm on people who don't already own a house is harder to see.

> Rising prices seem good superficially because a lot of people own houses and that means everyone is getting rich!

But this only helps people who own multiple houses, or don't plan to live in one. If you need a house, the gain you get from selling your existing house after appreciation is necessarily offset by the loss you take buying an appreciated replacement house.

You can't get rich, or benefit at all, from a nominal appreciation in the "price" of something you can't sell.

Sure you can benefit! You can take out a home equity line of credit and cross your fingers that it doesn't come back to bite you.

An outstanding loan secured by something that you can't lose makes your situation worse, not better. Taking out a line of credit is not fundamentally different from selling the security. :p

Plus the extra money helps you when you buy a bigger house! Never mind that anything you'll likely buy is appreciating too.

A reasonable concept is that late in life you will either move to a smaller house or move to a cheaper area or rent thereafter (or get a reverse mortgage or other financial instrument that allows you to lose some equity and still live in "your" house).

It's not as dire as you make out. That said, it's not as awesome as a lot of people seem to think.

When you downsize in retirement, you certainly can. Plenty of people plan to move to florida or other retirement towns when they're older. These places tend to be cheaper to buy houses in; off the beaten path, not near jobs, not good schools, etc - Things retirees don't care about, but youngsters do, that are major effects on housing prices. They can finance this by investing in that they live in in their youth, then selling. If you buy a house at $400,000, and it appreciates 10% over the next 10 years, it is now worth $440,000. You sell it, and move to a house that would have cost you $100,000... but that has appreciated at the same rate, now costing $110,000. You've 'made' $30k, despite appreciation.

Is it just me or does making $30k in 10 years sound absolutely terrible? That's $3k a year ...

There are so many cheaper ways to make an extra $3k per year. You could, for instance, spend 5 hours a week baby sitting for $12/hour.

In the UK (I have no experience of this type of finance anywhere else), interest rates improve as your loan to value percentage decreases. If the house increases in value by the time you come to re-mortgage, you're likely to get a better deal.

Again, this doesn't help people who are trying to buy for the first time.

Higher prices aren't good by themselves, what's supposed to be good is continuous appreciation. If we knew for a fact that home values would always go up relative to inflation, the sticker price of a home wouldn't matter all that much; as long as you could get:

* a loan with a long enough lifetime (so the payments are feasible) * a loan with a low enough interest rate (so the increased value of your home equity isn't overtaken by the amount you give to the bank) * some nice government subsidies in the form of the mortgage interest deduction

then at pretty much any point over the life of the loan you can sell the property and come out ahead, even if you never finished paying it off. Of course, if the crucial assumption that home prices always go up turns out to be faulty, anyone who bet on this strategy might be left with a home that's worth less than a loan they can't afford.

Disclaimer: I think I understand the concepts here but I'm no expert. Apologies if my choice of words and/or logic are completely wrong.

    >Texas and Atlanta have lots of land around them, but they did not have nearly the default problem of vegas and florida and california because they built a lot very quickly, so prices never rose dramatically.

I can't speak for Atlanta, but it's not just "lots of land" in Texas that spared it. Texas had limits on HELOCs[1] that spared it of most of the carnage.

[1] http://www.washingtonpost.com/wp-dyn/content/article/2010/04...

Prepayment seems like a pretty straightforward way to reduce risk. It feels like this article starts by claiming that prepayment adds unnecessary complexity to loans, moves on to show that default happens for precisely the reasons you would expect, and then says that we need to do more research on prepayment without really suggesting why prepayment might be a problem here.

Prepayment is a problem for the lender, not the borrower. Instead of just having to account for default risk, you also need to worry about the borrower repaying early. While that doesn't seem like it a big deal, it can be. If the bank expects to get twenty five more years worth of interest payments at 5%, the prevailing rate has now fallen to 3%, and you pay off the loan early, it has lost a lot of income it was expecting.

In many other countries fixed rate mortgages typically contain a prepayment penalty to compensate banks for this risk, but US mortgages almost never contain such provisions.

What other countries on Earth have prepay-100%-at-will as a standard feature of their housing markets?

Norway has prepayment of any amount without penalties (for variable interest loans, the most common variant here) by law.

I'm not surprised the 2008-2009 collapse created much stricter lending standards. I bought a condo last year and I was shocked (in a good way) at how difficult and laborious the process was, even for someone with great credit and a reasonable, stable income.

Strict sounds good, difficult and laborious not so good.

It's hard for you because you have good credit. It's not hard for people with bad credit, as is evidenced by Fannie and Freddie's latest 3%-down mortgage program.

The reason is that the very point of the new lending standards is to provide banks an exit strategy in the real estate market by inflating another bubble.

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