4.5% for a Thirty Year Mortgage?

The smarty pants constituents of the Treasury and the Congress have come up with a new idea aimed at spurring up demand in order to stabilize home prices. They want to offer 4.5% fixed rate thirty year mortgages to home buyers.

If you are a homebuyer, this offer sounds pretty sexy doesn't it? Well what if you are a responsible homeowner who keeps current on your current and has no intention of moving in the next five years? Does this offer sound sexy to you if you do not stand to benefit?

Is it safe to assume that you might even become angry at the fact that your new next door neighbor could be graced with a 4.5% rate and you (the responsible homeowner) is locked into a 6.5% 30 year prison sentence? I know that I would be livid and even pissed... upon first impression.

The general public is greeting this idea with sour disdain and anger. You should see the blogs. People are spitting venom. Why should responsible homeowners who are not buying a house in the near future (the majority of Americans) be penalized and left out in the cold? I understand the objections, but let me offer an idea on how you will benefit if this measure is passed by the Treasury.

Quite simply, those who do not stand to benefit directly from a bought down 4.5% interest rate, do stand to benefit indirectly. For example, if there are more buyers in your real estate market because of this artificially low rate, don't you suppose that it could positively affect your homes value? Now although you do not get the sweet deal on the mortgage directly, you do have a stake in this, afterall you are a homeowner!

Another way that you stand to benefit is quite simply microeconomic effects. Are you generally better off if the economy in your town is doing well? Of course. Did you know that when someone buys a new home, 17% to 20% of the sold homes value is spent in the first year by the new homeowners. Hard to believe, right? When you start to break it down, it makes sense. First, you have the real estate companies commission, then mortgage fees, appraisals, inspections, new furniture, moving companies, homeowners insurance, the new dog, etc. This starts to add up fast and it greatly benefits the economy.

Now I would like to state my disagreement as to how the Treasury plans to pull this off. Paulson, Bernanke, and all the other muckity mucks are astounded at the fact that 10 year treasury bills have a yield of 2.65 percent which is really cheap. This allows the Treasury to borrow money at 2.65% and then lend it out at 4.5 %, therefore capturing a handsome profit. Sounds great, doesn't it? This idea scares the hell out of me.

First of all, what happens when interest rates go up during the holding period of these discounted debt instruments? Lets take a savings bond for example. Lets say you buy a $100 30 year savings bond at a 4.5% interest rate in December of 2008. You are very happy because 4.5% is a great rate to have on a government insured investment. Let's fast forward to July of 2011. Interest rates on 30 year savings bonds are now 8%. How does this effect the value of your hypothetical savings bond? It literally pulverizes its value. You still get the same interest payment, however the face value of the investment greatly diminishes. If you hold it for the entire 30 year period, you will not be materially affected for the most part. However, what if you need to liquidate it to honor a short term obligation, or any obligation at all?

Do you really think the Treasury will hold these discounted mortgages for the entire 30 period? My sources point to "NO." In light of the aforementioned, this would leave the Treasury exposed to unwarranted risk. Interest rates will go up dramatically when the economy recovers. I think this would be opening Pandora's box. Let me offer a different approach.

Instead of actually owning the mortgages, let the government subsidize the lower rate to the lending institution. Let the government essentially buy down the rate to the artificially low level. This approach would be very similar to the way corn subsidies are delivered to farmers in the US. For example, interest rates on conventional 30 year fixed mortgages are 5.37%. JP Morgan Chase funds the mortgage and receives 5.37% of the principal balance over 30 years. The homeowner involved in this mortgage pays 4.5% a year over thirty years. So who fills the 0.87% gap? Uncle Sam does! Considering that the Median Home Sale price in the US is $191,000, this would equate to a $1,661.7 subsidy per year, or $49,851 over the life of the loan. In 2007 there were about 5 million homes sold. So to sponsor a project such as this, it would cost the government approximately $250 billion dollars over the entire life of the loans. $250 billion is the cost involved if every single one of these 5 million buyers applied for this mortgage, got it, and held the house, and did not refinance for 30 years. The probability of this happening is slim to none. On average people move every five years or so.

Let me know your feedback on this opinion piece!

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