How to keep the low teaser rate for your mortgage

Photo: Philip Brewer

Treasury Secretary Henry Paulson gave a speech yesterday, talking about the administration's plan to "address the challenges" of the housing market downturn and related credit squeeze. Part of their plan is to freeze the low teaser rate on the mortgages of people who have been making their mortgage payments okay, but who would face foreclosure if the rate went up. If you have a mortgage with one of those low teaser rates, you might be interested to know how to keep that lower rate--perhaps even get it back, if it has already reset.

Of course, if you were clever enough not to buy a house you can't afford, nobody wants to help you out. The treasury secretary made it very clear--people like you need no assistance:

. . . there are four categories of subprime borrowers. There are those who can afford their adjusted interest rate; these homeowners need no assistance. There are also a substantial number of homeowners who haven't been making payments at the starter rate on their subprime loan and may not have the financial wherewithal to sustain home ownership; some of these homeowners will become renters again. A third category of homeowners might choose to refinance their mortgage - putting them in a sustainable mortgage while keeping investors whole. This is the first, best option. Servicers should move quickly to assist those who can refinance.

And the fourth category is those with steady incomes and relatively clean payment histories who could afford the lower introductory mortgage rate but cannot afford the higher adjusted rate. We are focusing on this group, determining who they are and what steps may appropriately assist them. 

The treasury plan is to help people in categories three and four. Category three people will be helped by changing the rules to make it easier for the people who service loans to renegotiate the loan. As I described over the past couple of days, that's very difficult right now, because owner of the loan is a trust and the rules often don't allow such renegotiations. If they do allow them, each one allows them differently, meaning that the renegotiation has to be done one loan at a time, which is difficult and expensive. Paulson spoke of "streamlined" refinance and modification to turn a "fragmented, cumbersome process" into a "coordinated effort."

Perhaps even better than being in category three, though, would be to find yourself in category four.

At this stage, there are no rules written to establish who falls into this fourth category. However, it occurs to me that one of the reasons that someone might be able to afford a mortgage at a teaser rate, and yet not be able to afford it after a reset, is if someone has too much other debt. If that's the case, it might be awfully tempting for such someones to take on a big chunk of extra debt and thereby move themselves out of category one and into category four.

It seems clear that if you just blow all that money on high living (or, you know, medical bills), that you'd find yourself in category four. (Don't borrow too much and put yourself into category two. That'd suck.) But maybe there'd be some way to borrow the money and then spend it not on high living, but rather something of lasting value. Depending on exactly how the rules end up getting written, it might be something as simple as savings bonds; it might have to be something risky like land or a long-term, interest-free loan to your brother-in-law. Then, once you'd kept your loan from reseting, you could probably get your money back--if whatever you bought really was a thing of lasting value--and pay off that extra loan that put you into category four.

There will no doubt be rules to try to prevent that sort of finagling. Depending on exactly what the rules are, it might be difficult or impossible to put yourself in category four. But, whatever the rules are, there will definitely be people who do exactly that. That's just one reason this sort of thing is a bad public policy.

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Guest's picture

Teaser rates can be a good thing, if:

Your house value increases dramatically
Your payrate increases
They enable you to get into a house you can afford earlier

If all three of these aren't true, a teaser rate is a bad idea, all around.

With a teaser rate, you have negative amortization. What this means is that you aren't even paying the full interest on your house, and are making no dent at all in the principle.

For one year, this can really help someone out.

Extend this idea over a longer stretch of time though, particularly with stagnant or falling house values, and you quickly owe far more than your house was ever worth, and more than it is currently worth.

This traps you upside down in a house you can't afford, and have no way of getting out of. Not a good idea.

Philip Brewer's picture

On at least some mortgages with teaser rates, the teaser rate really is the rate being charged. (That is, there's no negative amortization.) If that rate is frozen, the homeowner does come out ahead--he's borrowing money at a below-market rate for an extended period of time.

Of course, you're right, that the borrower only really comes out ahead if he or she goes on to use the period of below-market rates to pay down extra principal--which is just the sort of behavior that would probably lead to the loss of the freeze, as it would be proof that the borrower is really in category one.

Guest's picture

This is a great analysis. I blogged it:

Like the credit card companies, that want you to keep on paying for as long as you can, the mortgage industry needs this to keep people just afloat enough. But in another few years, when the teaser rate freeze is over, many people (and I dare say the economy as well) will be right in the same place as it is now.

Guest's picture

Government interference created the subprime mess - 3 years ago Greenspan URGED people to get adjustable mortgages. He also - if you remember - kept the Fed Rate artificially low creating a non-incentive to saving.

Now, Government is poised to make the mess even worse. What happened to the FREE MARKET? What happened to individuals taking responsibilities for their own actions?

I'm really sick and tired of government involvement in every aspect of personal life. What scares me the most, is most people don't even perceive what's happening. The tyranny of the majority is the future.

The government, the all-wise government - will soon take a similar tack with the Social Security & Medicare Crisis. As you may, or may not, be aware, both programs are destined to go broke. Of course, the programs will become 'means tested' meaning that those who saved, who scrimped, who were smart enough to save for their own retirements and medical expenses in old age, will be dropped from the system. Those unfortunate 'victims' who were too dumb or lacked any foresight and/or took no personal responsibility for themselves, will of course be taken care of.

Am I the only one that sees the absurdity?