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The future of mortgages

Housing Trends
August 20, 2022
Our nation has a housing crisis.

The demographic trends driving America’s housing market are impossible to ignore: our country is creating households faster than we’re building houses. Structural shortages in available homes for sale push housing prices higher…[with] troubling realities of both sides of the housing market’s two historical models. The first model is: you own a home you call your own, typically with a multi-decade mortgage.

Shelter is one of our most basic needs. In a world where limited access to home ownership continues to be a driving force behind inequality.

Selected excerpts from Marc Andreessen’s note Investing in Flow.  

The problem is real: housing is broken, both homeownership and renting. It’s a basic unmet need that’s a driving force behind inequality.

Reading Mr. Andreessen’s thesis, I felt emboldened to help bring the Altgage mission to life: equity and equality through homeownership. We are tackling many problems with the first model of housing. Mortgage’s build home equity, but amortization makes building equity asymmetric. Amortization schedules work by fixing the mortgage payment based on the loan amount, term, and interest rate. Amortization calculators determine a series of interest payments in full and a small portion of principal payments. In 15yrs or half the time of a 30yr mortgage, perhaps 1/3rd of the loan is paid back. That is the fundamental inequality of amortization. The problem of inequality in a multi-decade liability is exacerbated by selling real estate. The cost of the transaction (8-10%) sets you back a few years. The first 10% of principal takes ~4yrs to repay, but the last 10% only takes 18 months. A new home purchase starts amortization from year one. The average American will move or refinance three times, with net worth taking a hit each time where it hurts the most. Refinancing also restarts amortization. The promise of refinancing is good: lower the monthly cost of your loan, but the execution is lacking. Refinancing often increases term lengths and can increase the total interest expense, measured in TIP, despite a lower rate. Mortgage interest is a function of rate & time. The latter is overlooked. Paying down your mortgage at 5% yields a risk-free return equal to your interest rate that can compound over three decades, risk-free and tax-free. Both benefits are monumental!

30-year mortgages are priced from a baseline of 10-year treasury yields. If the 10Y T-note offers 3%, lenders add a ~2% margin on top and offer mortgages at 5% to prospective borrowers. The spread can vary, but the correlation is tight. Because there is more demand for mortgages (~$12T) than outstanding money in bank savings accounts (~$1T), housing finance is enabled by a robust secondary market. The primary market refers to home buyers-borrowers, and lenders (banks and mortgage brokers). The secondary market refers to government-sponsored agencies (e.g., Fannie Mae and Freddie Mac) and investors who buy packages of loans that offer a predictable return. Mortgage-backed securities are considered very low-risk investments with returns ~2% higher than the 10Y T-note. Investing into a pool of mortgages has systematic risk (as evidenced by the housing collapse of 2008), but I would argue that investing in your mortgage is risk-free. If you pay $100 towards your mortgage note at 5%, you are guaranteed $5 of savings in year one and every year thereafter. The total return of the first $100 investment isn't $150 ($5 interest savings/yr x 30); it's $347. The kicker is compounding and especially favors pre-payment in long-term loans. The same $100 investment in year 10 only returns $172 or slightly less than 50% of $347. The value of a $100 investment in year 29 is $5. Mortgage prepayments are sensitive to rates and time. Bi-weekly mortgage payment plans add one extra payment each year but do not account for decreasing marginal utility as time elapses.

Because compounded interest savings manifest as principal pay-off, no taxes are owed. Bond investors have to pay taxes on coupon payments. Comparing an investment into your mortgage versus a stock market return isn't an apples-to-apples comparison because of the difference in risk profile. Stocks on avg. do return 10% but not every year. In the first half of 2022, the stock market fell by 20%. In years that returned 10% and you sold, the after-tax return would be closer to 7-8%%. Inexpensive index-based investing is the best ROI available, as long as you remain invested for 20+Yrs, and don't try to time the market with dollar cost averaging. If you never sell stocks, your mortgage dollars may be better with the rest of our portfolio. Ultimately, it's a question of portfolio allocation. A small contribution to your home has high economic utility and can alter the trajectory of your wealth. 80% of the median American's wealth is in home equity. That's a terrible statistic because home equity is illiquid and not diversified. You can live in a home, but you cannot eat it. Top decile Americans have less than 30% of their net worth in home equity. A smaller real-estate position implies greater wealth. The irony of wealth is that it's managed only for the rich. The rest of us need it too, even if the thing being managed is a multi-decade liability. Wealth is the difference between assets and liabilities

At Altgage, we start by optimizing the economic utility of principal pre-payments. Economic utility is based on total interest savings and the size of pre-payment (+10-20%) relative to the rate of equity accumulation (~70-100%). As time progresses, pre-payments decline and are eliminated between yrs 10-13. Compounding does the rest. The result is fewer total contributions and higher nominal savings versus a static pre-payment plan. The case for pre-payment does not end with your first mortgage. When you refinance, pre-payments can be adjusted to avoid re-amortization. If you refi in year 6, you can pay your next mortgage as if there are only 24yrs left. If you refi to a lower rate, holding payments constant can further shorten the mortgage. Re-amortizing further extends a multi-decade liability. Mortgages should be fast, affordable, and adapt to life’s changing needs. We believe that a multi-decade problem requires a multi-decade solution that is lender agnostic and customer-centric. The Altgage platform connects to a majority of mortgage servicers to securely enable principal PrePayments.  We also track interest rates to help lower the cost of a mortgage with below market prices. Altgage is building the future of mortgages as a lifelong source of wealth and a path to greater equality through homeownership.

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