Home Mortgage Loans: When Flexibility is a Vice

When people own big houses they tend to think that they have acquired enough equity so that there is little to no need to save, as if they were saving through the ownership of their houses for generations to come. But one day you realize that you are out of a job, you can’t pay the mortgage company, and even if you decided to sell the house the mortgage amount you’d owe would exceed the real market value of your house (along with due taxes). That is when the real problems start?! Well, not necessarily.

If you have purchased your house without a (substantial) down payment and you have not pre-empted your payment schedule with sizeable advance payments, periodic loan payments to a mortgage company must have been like paying a rent on a monthly basis to a landlord, so there is no real sense of ownership involved and giving up your property sounds relatively easy. 

On the other hand, when you have a house with substantial down payment and investment in foreclosure and you see your housing value deteriorate every day even though your monthly payments remain about the same, then you realize the extent of an imminent tragedy. So, paying too much and too soon and being anxious here is not good at all and it has to do with the kind of “flexibility” that your payment scheme provides to you.  

No To Variable Rate Loans; Yes To Fixed Rate Loans

Did I mention the payment scheme?! Yes I did and that’s why I think that Variable Rate (VR) home loans (I mean standard VR; basic VR loans are fine, as they are the most primitive and option-less) are inferior to Fixed Rate (FR) loans (and Home Equity Loans—discussed below) because VR loans provide “wrong” incentives— to invest in your house too much and too soon when you have a secure, well-paying job, in the form of pre-empting your payment schedule by making payments in excess of set minimum monthly payments (under the “redraw” facility clause) and lose it all when you lose a steady source of income. 

In other words, you can pay as much money out of your pocket as you like for home financing needs and the redraw facility clause provides for the accumulation of the advance payment portions, with the ability to draw down on those for the home financing needs only. Put it simply, the mortgage company says to you, pay me as much as you want and as fast as you want and all will go to your home financing.

People generally value when they have open options, but in a crisis situation like this recent and on-going one, you become what I term a “seller’s hostage” in reference to the discussed situation: you pay too much too soon, and end up having nothing.  

Even though VR loans’ interest payments are not locked (unlike FR loans) but vary in line with the Federal Reserve’s interest rate policies, so that interest payments tend to go down during a recession, yet allowing preemptive payments and the redraw facility is a kind of flexibility that is not virtuous at all in a crisis situation and runs counter to a basic human motivation. 

Under fixed rate loans, on the other hand, you are not permitted to make additional payments over and above the scheduled payments without incurring penalty fees and there is no redraw facility. (The idea is, you can’t close the balance on your loan too soon because should interest rates go down in the future—what the mortgage company counts on—you are locked with higher rates to pay in FR loans.) Even though FR loans do penalize you should you attempt to refinance or sell your house till the maturity of a fixed period is reached, who cares in a major crisis situation like this?! When that maturity period is never reached anyway, for most home owners facing foreclosure. Also, if you really want to pay in advance you can still do that if you agree to pay a penalty. So fixed rate loans are the best!—primarily because they discourage you to pay too much too soon!

Home Equity Loans

Home equity loans can be better or riskier than Fixed Rate loans depending on the type of personality, but clearly better than Variable Rate loans. And yet the flexibility options that home equity loans afford become a vice rather than a virtue: these loans like VR loans allow you to make any amounts of extra payments at any time without penalty and also allow usage of the credit limit (up to 80-90 percent of the property value) for ANY purpose, including personal living expenses, such as buying food, clothes, etc like charging a credit card. As long as you pay an outstanding balance every month, which amounts to at least monthly interest payments, and should you lose your job—your primary income source—you only pay interest, at least you can bail yourself out with less losses than in Variable Rate loans’ situation, because you have at least used part of your payments for personal consumption unrelated to home financing. In addition, some type of spending, like personal pleasure consumption will not be recoverable and you get away with that part. Hence, home equity loans are a little bit better than VR loans but far worse than FR loans in this sense. It is no secret that home equity loan owners suffered a great deal during this crisis.

This crisis has taught us that the real flexibility is the flexibility of mind AND money not being tied up to big “eternal” projects. Even brick and mortars are sometimes gone and life is full of surprises. 

Memento Mori! Carpe Diem!

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Music all the brilliant and familiar tunes and memories that mollify our lonely spirits. Silvio Referati