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July 20, 2005
David Miles Speaks!
I got David Miles on the phone today and he sent me a picture. Here is the real David Miles, chief U.K. economist of Morgan Stanley. As you can see, he is less insane-looking than the David Miles I pictured in my last post:
Miles has an idea for a new kind of mortgage that sounds very smart to me, even though he says it's "nothing specially, really."
He mentioned his mortgage concept last year in a special report on the British mortgage market that he did for Her Majesty's Treasury. (Go to page 73, fixed-rate mortgages with stepped-up repayment schedules).
Here's his idea: A safe, fixed-rate mortgage that competes with risky adjustable-rate mortgages by offering a low initial payment. Payments go up over time, as they do with an ARM. But the payment schedule is spelled out in advance, unlike with an ARM, where you never know what's coming.
The reason payments start out low and rise over time is that in the beginning, the mortgage is interest-only. No payments of principal. As the years go by, payments rise gradually because more principal gets paid off. It fully amortizes in, say, 25 or 30 years.
There have been fixed-rate loans in the past with low starting payments, but they often involved negative amortization--the initial payments weren't even enough to cover all the interest, let alone any principal. Payments eventually had to jump a lot to pay off the back interest that got rolled into the loan. Miles says that with today's low interest rates, lenders could offer quite low initial rates even without dipping into neg am.
Here's what Miles told me:
The way the world is in the UK right now, if you're just desperate to get the lowest payment up front, you're going to be pushed toward a variable rate mortgage. You're having to then take on the uncertainty about what future payments will be.
Very cautious people might quibble that Miles's loan would be dangerous for borrowers who can't handle rising payments. But it's a lot safer than most ARMs, with which it would compete.
Is anyone already offering this kind of loan? If not, why not?
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It sounds like a very good idea. But I already worry that first-time homebuyers are taught to assume that their incomes will rise over time and therefore take on mortgages that are a real stretch. What happens when they then suddenly lose their job? And have to take a lower-paying one (as has happened to so many people I know who got laid off in the past five years). Sure, this idea is better than ARMs, but I still think most people should grab a 30-year fixed and be happy they locked in the rate they did.
Posted by: Amey at July 20, 2005 06:01 PM
I enjoyed your post today. Something similar is available in the good ole' USA right now.
It is called a "Temporary Buydown" or "Lender Funded Buydown".
In the case of the Lender Funded Buydown the lender is funding a lower "payment rate" for the buyer upfront in return for a little higher yield for the loan over the long haul.
A 3-2-1 Lender Funded Buydown for example would start with an intial "payment rate" of 3.5% in year one, 4.5% in year two, 5.5% in year three, and 6.5% years 4-30.
I use the above numbers purely for illustration, but they are in the ballpark.
The nice thing for the client is a very attractive beginning payment rate and they know upfront what changes can occur.
Posted by: David Porter at July 20, 2005 06:38 PM
This sounds very similar to a student loan with graduated payment schedule.
Posted by: Wes at July 21, 2005 02:38 PM