In what has to be one of the most bizarre developments in real estate this year, the ivory-tower folks at the Fed, of all people, dreamed up a creative new loan that would not require a down payment. Then they used the dreaded COFI term from neg-am mortgage days! No word on when these might be available, if ever:
Abstract: The 30-year fixed-rate fully amortizing mortgage (or “traditional fixed-rate mortgage”) was a substantial innovation when first developed during the Great Depression. However, it has three major flaws. First, because homeowner equity accumulates slowly during the first decade, homeowners are essentially renting their homes from lenders. With so little equity accumulation, many lenders require large down payments. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowner might have better uses for this money. Third, refinancing mortgages is often very costly.
We propose a new fixed-rate mortgage, called the Fixed-Payment-COFI mortgage (or “Fixed-COFI mortgage”), that resolves these three flaws.
This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and no down payment. Also, unlike traditional fixed-rate mortgages, Fixed-COFI mortgages do not bundle mortgage financing with compensation paid to capital markets investors for bearing prepayment risks; instead, this money is directed toward purchasing the home. The Fixed-COFI mortgage exploits the often-present prepayment-risk wedge between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate.
Committing to a savings program based on the difference between fixed-rate mortgage payments and payments based on COFI plus a margin, the homeowner uses this wedge to accumulate home equity quickly. In addition, the Fixed-COFI mortgage is a highly profitable asset for many mortgage lenders. Fixed-COFI mortgages may help some renters gain access to homeownership. These renters may be, for example, paying rents as high as comparable mortgage payments in high-cost metropolitan areas but do not have enough savings for a down payment. The Fixed-COFI mortgage may help such renters, among others, purchase homes.
Keywords: COFI, Cost of funds, Financial institutions, Fixed-rate mortgage, Homeownership, Interest rates, Mortgages and credit
JtR: This sounds like the reverse of a neg-am mortgage, or a positive-amortizing loan where borrowers have a fixed payment as a ceiling, and then when rates float down, the difference is applied to the principal. But how much potential is there for your rate to drop when we’re at all-time lows? Maybe they are preparing a loan option for the day that rates rise substantially?
Terrible idea. But remember that the 30-year mortgage is not a product that would ever exist in a free market–the government created it, pushed it on homeowners and banks, and has subsidized it through insurance and other programs for 80 years. I fear this is just another way of keeping credit expanding to avoid market prices to find true demand for housing. I wonder how many millions of fewer single family homes, particularly suburban bombers, would have been created and sold without government backing. It is a big mess, but I don’t see how it unwinds even in my lifetime.