Friday, July 27, 2012

Student Loan Apples and Mortgage Loan Oranges

    For several months leading up to a July 1st deadline, the president's Twitter feed was filled with urgent warnings to followers to urge Congress to extend the interest rate reduction on Stafford student loans.  A few weeks ago, I wrote about the president's tendency for what Politico, in a case of anti-hyperbole, termed "hyperbole."  In reality, it was a blatant misstatement of fact, inflating the potential savings to students by a factor of eleven.  I didn't realize it at the time, but this deception had actually begun in April:

Incredibly, two months later, the president was using the same line, largely unchallenged.  The fact was that the $1,000 figure was the amount that a student loan holder would save over the life of the loan, generally 12 years.  The president's plan worked and Congress acquiesced rather than be blamed for sticking it to the poor students.

    Now that the president and Congress have saved certain student loan holders a whopping $7/month or 25¢/day, President Obama has turned his attention back to mortgage holders:

The president is harking back to a proposal he had set forth in February:
Broad Based Refinancing to Help Responsible Borrowers Save an Average of $3,000 per Year: The President’s plan will provide borrowers who are current on their payments with an opportunity to refinance and take advantage of historically low interest rates, cutting through the red tape that prevents these borrowers from saving hundreds of dollars a month and thousands of dollars a year.
Note that the annual savings claim is present again.  However, this time, there's actually something to it.    There is an example in the original proposal about how the savings are realized:

EXAMPLE: How Refinancing Can Benefit a Borrower With a Non-GSE Loan
 A borrower has a non-GSE mortgage originated in 2005 with a 6 percent rate and an initial balance of $300,000 – resulting in monthly payments of about $1,800.
 The outstanding balance is now about $272,000 and the borrower’s home is now worth $225,000, leaving the borrower underwater (with a loan-to-value ratio of about 120%).
 Though the borrower has been paying his mortgage on time, he cannot refinance at today’s historically low rates.
 Under the President’s legislative plan, the borrower would be eligible to refinance into a 4.25% percent 30-year loan, which would reduce monthly payments by about $460 a month.

Reducing payments $460/month results in a cash flow savings of $5,520.  (Actual "savings" would be less; $272,000 at 6% for a year is $16,320; $272,000 at 4.25% for a year is $11,560; the interest savings is $4,760.  This is a rough calculation; the real savings would be less as the years go after taking the amortization of principal into account.) However, this example does not represent the "average" borrower.   The average balance on mortgages these days is about $155,000, not $272,000.
    So I have used this amount, $155,000, plus the current average rate borrowers are paying on outstanding mortgages (5.09% per the Commerce Department) and the current average 30-year fixed mortgage interest rate (3.53% per Freddie Mac.)  The above example then becomes a $176,000 mortgage taken out in 2005 at 5.09% with payments of $955 per month.  The principal balance is now $155,000.  Refinancing at 3.53% would yield a monthly payment of $696 per month, a reduction of $259 per month, or $3,108 over the course of a year.  Bingo!  The president's claim is correct!
    Sort of.  As I indicated above, there is a difference between cash flow "savings" and actual "savings."  Let's say you owe someone $500 and agree to pay them $100/year for 5 years.  Times are tough, so they agree to have you pay them back over 10 years at $50/year.  Your cash flow savings is $50/year, but in reality you have "saved" nothing - you still have to repay $1,000.  And if they are charging you interest, the longer term will actually cost you more.
    That is similar to what is going on here with the president's claim of a $3,000/year savings.  It's a cash flow savings.  Granted, that's what most people are interested in, and the benefit to household budgets in tough economic times would certainly be tangible.  But during the student loan debate, the emphasis (obscured as it was) was on total savings over the course of the loan, not the 25¢ per day.
    So what is the real savings for the average mortgage holder?  Under the original loan, $955/month for 30 years is $343,800.  Under the refinance, the mortgage holder pays $955/month for 7 years, or $80,220 (2005-2011).  Beginning in 2012, the payment is $696/month, but due to the refinance, the term of the loan now extends 30 years again, not just the 23 years left from the original mortgage term.  A payment of $696/month for 30 years is $250,560, plus the $80,220 already paid totals $330,780.  The difference after refinancing?  An actual dollar savings over the life of the loan of $13,020, or $434/year.  Still a savings, yes, but the mortgage holder is in debt seven years longer than before.  (Based on his $5 trillion increase in the national debt, long-term debt doesn't weigh heavily on the mind of the president.)

    I know, I know... I wrote the above and even I can barely follow it.  Accountants might be the only ones reading these words since non-accountants eyes probably glazed over several paragraphs ago.  But the bottom line is this: the president ignored and even distorted the 25¢ per day cash flow savings that was at stake during the student loan debate and used a trumped up "additional $1,000 in debt... per year" to sell his position.  Now that the immediate cash flow savings is truly significant, the president focuses there rather than the less attractive but comparable $1.19/day savings over the life of the refinanced mortgage.  Time and again, Barack Obama has shown he will stretch the truth or frame the facts in whatever way is most favorable to his positions.  And time and again, his opponents must call him on it.

1 comment:

  1. For each year that Congress doesn't pass a budget the Country racks up debt of $4M every minute. Vote Obama/Biden.