An innovative new mortgage program is getting a lot of favorable media, as it is designed to help low-income borrowers and first-time buyers get into the housing market and stay there. It's called Wealth Building Home Loan and it is a 15-year mortgage which allows home buyers to build equity much faster than they would with a standard 30-year loan. Until now, the typical loan people think of when considering a first-time mortgage is an FHA, or U.S. Federal Housing Administration mortgage insurance- backed mortgage loan.
Typical home loan borrowing
Traditionally, payment affordability leads most first-time buyers to choose 30-year fixed-rate mortgages. You can buy a lot more home and there aren’t many surprises. The problem is, it generally takes 30 years until a 30-year fixed mortgage is paid off. In the meantime, you pay mostly interest for the first 10 to 20 years, and it’s not until late in the amortization period that payments go primarily toward principal. So, you don’t really start owning much of your home until very late in the loan.
This can create problems down the road, especially for those who put little down on their home purchase. If borrowers fall behind on payments, and have little home equity at risk, lenders don’t have much security for their investment. Borrowers can simply walk away if things go wrong.
But the alternative -- traditional 15-year fixed rate mortgages -- aren’t cheap. The borrower has half the amount of time to pay off roughly the same amount borrowed, so the monthly payments on 15-year loans are much higher.
An FHA alternative?
Providing an FHA alternative was in fact much of the inspiration for the new loan. Its creators claim the FHA overcharges borrowers and sticks them with costly mortgage insurance premiums. And, until now, low-income borrowers and first-time buyers haven’t had many other options to an FHA loan for buying a home.
With a Wealth Building Home Loan, borrowers will get more than 90 percent of the purchasing power they’d normally get with the FHA program with the standard 30-year fixed loan at three percent down, according to proponents.
Much of the problem associated with the FHA model is due to trying to make them more affordable at the expense of building borrower equity and wealth. In the beginning, the Federal Housing Administration insured mostly shorter-term, 15- to 25-year mortgages, and required 20 percent down payments, as well as a careful review of a borrower's household budget, and rigorous appraisal standards.
But, beginning in the late 1950s, government housing policy shifted, and lenders began using looser underwriting standards. And, more recently, low-income borrowers and first-time buyers were coaxed into the market by making monthly payments more affordable. The result has been saddling these buyers with overwhelmingly high-risk loans. Once something goes wrong -- a job loss, major illness, or divorce -- there is little or no equity acting as insurance.
Details of Wealth Building Home Loan
The opportunity to build ownership far more rapidly by spending a little more each month is the primary purpose of the Wealth Building Home Loan. The happy consequence of doing so, proponents contend, is the quick creation of an equity cushion to fall back on, should home prices go south soon after buying. This equity stake greatly reduces the chances of going into foreclosure.
To make the payments more affordable, the loan is offered at an interest rate about three-quarters of a point below the 30-year FHA rate. If borrowers wish, they can buy down the rate even further. For every 1 percent of the loan amount the borrower puts up as a down payment, the interest rate will be lowered by half a percentage point, which is twice as much as usual. So, a $6,000 down payment on a $100,000 mortgage at 3 percent would bring the rate down to zero, meaning that every penny spent on the monthly payment would go to the principal (the amount borrowed or the amount still owed on a loan, separate from interest).
In the first three years of the Wealth Building Home Loan, 77 percent of the monthly payments go to paying off the loan's principal, whereas 68 percent of the payments of a standard 30-year mortgage are interest to the lender.
So, with this program, low-income borrowers and first-time buyers pay down their mortgages faster without having to pay a lot more and they build more home equity in a shorter period of time. Compare this to the latest mortgage rates are in your area.
The lenders benefit as well by facing less exposure to the credit risks of high loan-to-value financing.
This is assured by underwriters who will make sure you have enough money left over after you make your house payment to cover all your other monthly expenses. That way, should you have a financial setback, there will be enough money coming in that you can still make your payments and won't fall into foreclosure.
Doubts from FHA supporters
There are definitely doubters and critics, however, of the Wealth Building Home Loan concept. They complain it is not a logical replacement for the FHA loan program. They point out, if borrowers use their limited money to buy down their interest rate rather than make a down payment, they deprive themselves of a quick equity stake.
They also complain that these loans, with zero down, no mortgage insurance, and a low interest rate, will have to be held on to by the lenders, instead of being sold on the secondary market. This is likely to severely limit their availability. Even if the new loans could be offered on a large scale, they claim, it's still questionable whether subsidizing the program would be a better use of government dollars than government support of the FHA program.
What can't be denied, however, is the hope this program offers of owning a home free and clear in 15 years. Think of the freedom the resulting extra cash and credit standing will bring a homeowner when that house payment becomes a memory.
Initially, the Wealth Building Home Loan will be made available through the 37 offices of the Neighborhood Assistance Corporation of America. NACA will act as mortgage originator for Bank of America under a $10-billion contract. Some 10 other institutions are also involved in startup talks.
What's more, there's word of a similar financing tool designed for middle-income borrowers in the works.
This will be a developing story over the many months and even years it may take for the concept to become established. We will, of course, follow it closely for you.