Seeking a way to put more money into homeowners’ pockets, Director of Housing Finance and Regional Economics Ken Fears at the National Association of Realtors (NAR) has put forth a proposed new mortgage loan product that aims to blend several existing mortgage structures into one, taking the pros of each while minimizing their cons.
The concept, called the Blended Rate Equity Driver (BRED) mortgage, may give homeowners a way to build equity in their homes faster than they currently do with a traditional 30-year, fixed rate mortgage (FRM).
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Although the FRM is popular among consumers, allowing them to easily budget for relatively low monthly payments over a 30-year amortization period and offering pricing advantages for the secondary market, this mortgage has many drawbacks — the biggest of which, NAR argues, is the time it takes homeowners to build equity, making it difficult for homeowners to refinance or sell their homes.
“The housing market would benefit from innovations geared toward building equity, even in a rising rate environment,” stated Fears.
“Equity helps a borrower to refinance during an economic crisis, to save for a trade-up purchase, to access a business loan and to shape one’s retirement. Balancing the need for more equity with other consumer priorities like affordability is the key and can be done.”
“The housing market would benefit from innovations geared toward building equity, even in a rising rate environment.” – NAR Director of Housing Finance and Regional Economics Ken Fears
By combining the most dominant and liquid mortgage structures — the 30-year FRM, a 15-year FRM and the 5/1 adjustable rate mortgage (ARM) — into a single, first-lien mortgage, the BRED mortgage helps to build equity faster through principle payments, Fears stated.
For a first‐time buyer who can afford a slightly higher payment, a BRED would comprise 80 percent 30-year FRM and 20 percent 15-FRM. The payment on a $200,000 home with a 3 percent down payment would be $85 more a month than a 30-year FRM.
Although this may seem like the consumer would need a slightly higher income in order to make those higher payments, NAR said the consumer ends up with 40 percent more equity after five years.
“Rents have grown dramatically in today’s market, and a common complaint is that consumers can afford a mortgage payment, but not the down payment,” Fears stated. “This product could be a natural fit in high-cost markets and help the buyer to build equity rapidly for an eventual trade-up.”
Alternatively, for a trade-up buyer choosing between the low payment of an ARM and that of a 30-year FRM, the BRED could be structured with 60 percent 5/1 ARM, 30 percent 30-year FRM and 10 percent 15-year FRM. The borrower’s payment in this scenario would be about $20 less per month with a 10 percent down payment on a $200,000 home. Then, at the end of 10 years, the monthly payment would rise 23 percent above the initial payment. At year 15, the 15-year mortgage is fully paid, and the payment falls closer to that of the 30-year FRM, NAR explained.
For a consumer who wants to complete payments in 15 years, but who can’t afford the high introductory payment of a 15-year FRM, the BRED mortgage could be structured to include 60 percent 15-year FRM and 40 percent 30-year FRM. This scenario would lower payments by $160 per month over a 15-year FRM and more than double the equity accrued after five years compared to the 30-year FRM. The payment would fall by nearly $800 after 15 years compared to a 30-year FRM, presenting a good option for homeowners who anticipate funding college tuition in the future or contemplating a partial retirement.
With equity accruing faster in the BRED mortgage structure, a mortgage with private mortgage insurance (PMI) would reach the 78-percent requirement for release faster than a 30-year FRM, NAR pointed out.
Fears noted that the (still theoretical) BRED mortgage would not be a “silver bullet” to solve the equity problem. It may seem like “an odd duck when juxtaposed with the current market,” he conceded.
He suggested that lenders could issue a covered bond or securitization for the fixed-rate portion of the pool while retaining the ARM portion in portfolio, allowing the lender to offload the interest-rate risk while using the ARM to retain a portion of the credit risk and satisfy regulatory requirements.
In addition, the Federal Home Loan Banks could act as a conduit for smaller lenders to pool BREDs, and aggregate and funnel them to a selected special purpose vehicle for securitization.
“What the BRED does is to provide homeowners with more options, while putting more equity in their pockets,” Fears concluded.
Editor’s note: This story has been updated.
