Random thoughts on the housing market

The Chicago Tribune‘s Mary Umberger reports on the emergence of a new kind of mortgage:

When Jim Erbach set out earlier this year to refinance his mortgage, his credit union told him about a new loan that would cut his monthly payments by nearly $200. “I’m cheap,” said Erbach, who signed on for a 40-year mortgage. He is also 73 years old. “I have one objective in mind, to reduce the current costs of my expenses,” explains the retired fleet manager who lives on a fixed income. The Northwest Side man is in a pilot program to test consumer reaction to a relatively rare mortgage animal: the 40-year, fixed-rate loan. It’s an experiment of 16 credit unions nationwide in partnership with Fannie Mae, which next year will decide whether to roll out the loans on a broad scale. While a few banks offer the occasional 40-year fixed-rate mortgage, a stamp of approval from Fannie Mae could standardize such loans. Officials at Fannie Mae and at Baxter Credit Union in Vernon Hills, which is participating in the test program, see the 40-year loans as a way to turn more Americans into homeowners. Critics view the loans as creating more nightmares in a society saddled with debt. “I thought the point of buying a home was to own it,” said Amelia Tyagi, co-author of “The Two-Income Trap,” an examination of American household debt. “With this thing, you pay until you die.”

The basic concern of critics is that: a) this kind of mortgage saddles people with too much debt; and b) the lower per-month costs permits people who are genuinely bad credit risks to get credit, increasing nonperformance rates; and c) a secular increase in housing prices as demand increases. My gut instinct is that these costs are far outweighed by the benefits of expanding the number of homeowners. Beyond expanding the investing class, this is particularly true if the introduction of this kind of mortgage instrument creates new neighborhoods of homeowners instead of renters. This is Mickey Kaus’ territory, but I have to think that there are positive spillover effects from having a critical mass of homeowners in a neighborhood — a greater investment in preserving social ties, an incentive to increase property values, and indirect feedback effects on education funding. [But the example in the story is about an old guy buying a house.–ed. Yes, but this points to two other reasons why this is a good thing. First, it means that a lot of homeowners are rationally looking at their homes as financial assets that are currently outperforming other investments. Second, a 40-year mortgage would seem to be a rational response to an increase in lifespan.] Of course, if we’re currently experiencing a housing bubble, then expanding mortgages at this juncture would not be a good thing. But I am cheered by the IMF’s recent World Economic Outlook, which includes an essay by Marco Terrones on the global housing boom. The basic conclusion of the piece is that, “The econometric results confirm that real house prices in industrial countries show high persistence, long-run reversion to fundamentals, and dependence on economic fundamentals.” and that in the United States, the recent run-up in prices are consistent with this trend.