Bailout

How to funnel money to bankers and brokers, housing edition

By Felix Salmon

Linda Stern has replied to my post about her dreadful advice to leverage up as much as you can to buy a house right now. And she’s not backing down:

My job is to write about what?s good for the consumer, not the bankers and brokers. And, for a young person who wants to own a house, the numbers say it?s better to squeeze together your 3.5 percent down payment and lock in a 30-year fixed rate loan now, at 4.87 percent (with deductible interest).

Got extra money? I?m guessing a nice balanced mutual fund will do better than 4.87 percent over 30 years…

And if you banked your cash instead of tying it up in your house, doesn?t that give you more leeway to pay your bills while you sort out your finances?

The line about “what?s good for the consumer, not the bankers and brokers” is truly astonishing. The argument here, if you don’t want to follow it back to the beginning, comes down to a simple choice: do you buy a house now with very little money down, or do you save up for a larger down payment? Linda recommends the former course of action, I think the latter is much more prudent. But what’s undeniable is that bankers and brokers will end up making much more money if you follow Linda’s advice than if you follow mine.

After all, the more that banks lend, the more money they make. If you maximize your borrowings, as Linda recommends, that’s extra profit for the banks. On top of that, Linda reckons it’s a good idea to use any excess cash not for your down payment (which would lower the amount you have to borrow and therefore lower the amount of money the bankers make) but rather for long-term investment in “a nice balanced mutual fund.” Which of course means profits for the fund managers and stockbrokers involved in selling you that fund. And we’re not done: the house you buy will probably be sold by a broker, who will profit 6% or so of the sale price. More money going to intermediaries.

And has Linda forgotten this bit, from her original post?

To get one of those 3.5 percent down payment loans, though, borrowers have to pay one percent up front and annual mortgage insurance premiums. Beginning on April 18, those premiums will rise 0.25 percentage points, to 1.1 percent for borrowers who put at least five percent down, and to 1.15 percent for borrowers who only put 3.5 percent down.

That’s 1.15% of the value of your mortgage every year for 30 years — all going directly to insurance premiums, which are a crucial part of the financial-services profit machine.

So if you want to do what’s best for the financial-services industry, and for bankers and brokers, you should definitely follow Linda’s advice.

Meanwhile, Linda does seem to be a bit fuzzy on what exactly you should do with the money you don’t put towards a down payment. On the one hand, she says it should be tied up in that mutual fund for the next 30 years, in the hope that it will return more than 4.87%. But on the other hand, she says that it should be “banked” so that you can “pay your bills.” Well, you can’t have it both ways. If you want the cash to be liquid and available for bill-paying, you shouldn’t invest it on a 30-year time horizon. (After all, as we saw during the crisis, people have a tendency to need cash at exactly the time their investments plunge in value.)

As for Linda’s “numbers,” I’m completely unconvinced that there’s any clear math showing that buying now makes lots of sense. Linda’s argument is based on speculation about the future — that interest rates and house prices are both going to go up over the next five years. That’s possible, of course. But it’s hardly an obvious mathematical truth. In recent years lots of people have lost lots of money by making exactly that bet. Which would seem to indicate that a bit of prudence, and saving up money for a decent down payment, makes a lot more sense than a speculative plunge into a highly-leveraged and extremely illiquid asset.

Full post as published by Macroprudential on March 09, 2011 (boomark / email).