Like Buying a House and Renting It to Yourself

Would you like to finance your dream home with a loan that builds equity twice as fast as a 30-year loan, has a much lower risk of default and helps you budget for your children’s higher education and save for retirement? Then the Wealth Building Home Loan may be the loan for you. My colleague at the American Enterprise Institute, Stephen Oliner, and I created this loan to serve the twin goals of providing a broad range of home buyers a more reliable and effective means of building wealth without relying on home price appreciation, while maintaining buying power similar to a 30-year loan.

How does the Wealth Building Home Loan help borrowers reliably build wealth? The loan is a 15-year, fully amortizing loan. This faster amortization means you build equity quicker and pay less interest. In the first three years of this loan about 75 percent of monthly mortgage payments pay off principal, creating a huge amount of equity, while for a 30-year loan, about 65 percent goes to pay interest. Buying a home with a Wealth Building Home Loan is very much like buying a house and then renting it to yourself!

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How does the Wealth Building Home Loan deliver more than 90 percent of the buying power of a traditional 30-year loan? Even before considering the unique features of this loan, the interest rate on a conventional 15-year loan is 0.75 percentage points below the Federal Housing Administration's 30-year rate in today’s market. The Wealth Building Home Loan has substantially lower expense to cover credit risk than the 30-year FHA loan because it is designed to be a safe mortgage with relatively few defaults. The strong savings component safely allows for a slightly higher housing debt-to-income ratio, adding to buying power. A maximum loan-to-value ratio of 100 percent allows for repurposing all or part of the down payment for a permanent interest rate buydown of about one percentage point. There are a number of other possible sources of funds available to a homebuyer to pay for the permanent interest rate buydown, including a concession paid by the seller or a gift from a family member. (Mom and dad, is it worth $6000 or so to get Johnny out of the basement?)

But isn’t it risky for the Wealth Building Home Loan to allow for a zero percent down payment? Within 10 months, a Wealth Building Home Loan with a zero down payment has a lower loan-to-value ratio than an FHA loan with 5 percent down. After the 41st month, the Wealth Building Home Loan drops below 80 percent loan-to-value ratio even without any house price appreciation, while the loan-to-value ratio on the FHA loan is still over 90 percent. The 15-year loan is an equity generating machine, which makes a down payment unnecessary – the funds are better used to fund the interest rate buydown.

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How does the Wealth Building Home Loan help budget for your children’s higher education and save for retirement? This loan is designed to support a life cycle approach to saving and spending. The key features of this approach are sustained saving for retirement, starting with one’s first job; right-sizing the home one buys; financing the home with a mortgage that builds equity quickly; and timing the payoff of the mortgage to free up cash flow to support major life cycle expenditures, such as children’s post-high school education. Adopting such an approach would go a long way toward strengthening household finances in the U.S. and would leave households better able to meet their financial goals given the necessary cutbacks in federal spending for retirement programs as the population ages.

Why is the 30-year mortgage not suitable for many borrowers? Because the loan principal on a 30-year mortgage amortizes very slowly, borrowers accumulate little housing wealth for many years, except in the unusual case of substantial house price appreciation. This creates two serious problems for many borrowers. First, the absence of substantial home equity – and the likelihood of negative equity should house prices fall – leaves borrowers with few options other than default if they encounter financial difficulty. And second, the slow amortization means that borrowers do not build the wealth to finance major life cycle spending needs.

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The Wealth Building Home Loan has received rave reviews in the national media – the Washington Post, New York Times, Los Angeles Times and NPR to name but a few. Oliner and I are working with lenders interested in rolling out the Wealth Building Home Loan. Check with your lender today and ask whether it plans to offer the Wealth Building Home Loan.