Most homeowners opt for fixed-rate mortgages because there aren’t any surprises. Many of them go with a 30-year term because it’s the norm, and also because it allows would-be homeowners to buy a lot more home.
The major downside is that a 30-year fixed mortgage takes 30 years to pay off. In other words, you pay a whole lot of interest over three decades, and you don’t really own much of your home for the bulk of the amortization period.
In fact, it’s not until late in the loan period that payments go primarily toward principal, as opposed to interest.
This can create problems down the road, especially for those who put little down on their home purchase.
After all, without any home equity, lenders don’t have a buffer in place if borrowers fall behind on payments. And borrowers who don’t have much (if any) skin in the game can simply walk away if things don’t go their way.
How About a 15-Year Fixed That Isn’t Super Expensive?
- The Wealth Building Home Loan (WBHL)
- Created by Edward Pinto and Stephen Oliner of the American Enterprise Institute
- Combines the affordability of a 30-year fixed
- With the equity building power of a 15-year fixed
Unfortunately, 15-year fixed mortgages aren’t cheap, seeing that the borrower has half the amount of time to pay off roughly the same sized loan.
This explains why 30-year loans continue to be a lot more popular, despite what I just said.
But that may all change with the advent of the Wealth Building Home Loan (WBHL), created by Edward Pinto and Stephen Oliner of the American Enterprise Institute (AEI).
In a nutshell, it combines the equity-building benefit of a 15-year fixed mortgage with the affordability of a 30-year fixed. So borrowers pay down their mortgages faster without breaking the bank.
Speaking of banks, borrowers also gain a lot more home equity in a shorter period of time, which greatly reduces the credit risk associated with extending high loan-to-value loans.
In fact, during the first three years of a WBHL, 77% of the monthly mortgage payment goes toward principal.
Compare that to a traditional 30-year fixed, where 68% goes toward interest. Sure, the payment is substantially lower, but the house still mostly belongs to the lender.
A 15-Year Fixed Rate Below 2%?
- The WBHL is a no down payment mortgage
- That relies on a rate buy down at the outset
- To lower the interest rate and make monthly payments similar to a 30-year loan
- Lenders are protected through sound underwriting and fast equity accrual
In order to keep monthly payments down and maintain home buying power, the AEI notes that a conventional 15-year fixed is priced around 0.75% below the going rate for a 30-year fixed FHA loan.
Additionally, the WBHL allows for zero down financing, with five percent in down payment funds repurposed for a permanent 1.25% rate buy down.
Its creators also claim that the annual credit risk expense on the WBHL is lower, and the strong savings component of the loan program allows for a slightly higher debt-to-income ratio.
The 15-year averages around 3.25% today, so borrowers could enjoy fixed rates in the high 1% range. Not too shabby.
All this apparently gives borrowers who go with a WBHL more than 90% of the purchasing power they’d normally get via the FHA and their standard 30-year fixed product with 3% down.
For the record, Pinto has long taken issue with the FHA for overcharging borrowers and sticking them with costly mortgage insurance premiums. Unfortunately, most renters need an FHA loan to buy a home, so there aren’t many other options.
While the WBHL certainly sounds like an interesting and potentially game-changing loan product, not everyone actually wants to pay off their mortgage faster. Some people would rather invest their money elsewhere.
But there are a lot of positives to the WBHL, both for borrowers and lenders, and it does make sense for lower-income borrowers to create wealth as opposed to dig deeper into debt.
This mindset could actually help us avoid another crisis, or at least postpone one.
The WBHL is being launched by the Neighborhood Assistance Corporation of America (NACA) and Bank of America this month.
Over the next few months, it will be rolled out to NACA’s 37 offices. A WBHL for middle-income home buyers is also in the pipeline. If interested, inquire with NACA.