Wikiality

By Robert Fischer | Published: October 27, 2006

Okay, the fact that this even exists is a distrubing tribute to the cult-like following of the the one-man satire who is Stephen Colbert.

Run-on prepositional clauses aside, I find Wikipedia to be an interesting reflection of the people who use and edit it. For instance, I popped onto Wikipedia to take a look at what it had to say about interest-only mortgages. Snuck in there was a random comment about the Great Depression, which I had to pull. The end of the paragraph on US Interest-Only Loans was:

This enables a borrower who expects to increase their salary substantially over the course of the loan to borrow more than they would have otherwise been able to afford. Interest-only loans were popular in the [[1920s]]. Due to the economic downturn and lack of work for the average person, there were many foreclosures during the [[Great Depression]] of the [[1930s]].

Uh, whether interest-only loans were popular in the 1920s or not is fine — but what does that have to do with the high foreclosure rate in the 1930s? The “economic downturn and lack of work for the average person” made any mortgage, interest-only or otherwise, an impossible burden (as Wikipedia talks about over on the article about the Great Depression, where this entire conversation belongs).

Now, it looks like the comment — a weird tack-on in the version I editted — started out as a passing comment in a larger conversation on the re-amortization after the interest-only period expires. Even then, it was a weird comment, without any obvious connection to the paragraph it resided in.

Somehow, however, that survived from April of 2004 until I caught it. Why would that be?

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  • bhurt-aw

    No comment on the Wikipedia thing- except to say that Wikipedia, while a good place to start researching something, should not be regarded as the final word in that subject (neither should the Encyclopedia Britannica, for that matter).

    As for interest-only mortages being a problem, they were a much bigger problem than normal loans were- because they depend upon your income not only remaining level, but actually increase with respect to inflation. So it’s not enough to just stay in place, you have get ahead. If you don’t, you’re screwed. And so is your lender, as well. If you just give up and mail the keys to the bank, the bank now owns a home it a) doesn’t want, and b) paid way to much for. Remember the bank’s out the money it loaned you- and in this case, it’s basically gaurenteed the house isn’t worth that much anymore.

    Except now things get complicated. One of the reasons the banks are willing to provide much more risky loans (well, other than the competitive pressure of cheap money) is that they think they are selling the risk to someone else- i.e. they’re risking someone else’s money. See, they immediately sell your loan to a mortage company, which packages your loan with a lot of others into a basket, and sells shares of the basket to hedge funds (not Jane St.), who buy the shares with money invested in them from “fund of funds” mutual funds, which are, um, heavily invested in by banks.

    What happens in practice here is that all the different layers of aglomeration and parcelling out tends to do is spread risk around- reward as well. So small amounts of loss tend to be shared by large numbers of people. If you default on your loan, a lot of people get hurt a little bit. Combined with reversion to the mean, this makes people think they have eliminated risk. The problem is if there are large numbers of defaults at the same time (or near enough). Then this risk sharing could bring everyone down simultaneously.

  • http://enfranchisedmind.com Candide

    As for interest-only mortages being a problem, they were a much bigger problem than normal loans were- because they depend upon your income not only remaining level, but actually increase with respect to inflation. So it’s not enough to just stay in place, you have get ahead.

    Ignore, for a minute, that this argument wasn’t made by the Wikipedia article, and that the catastrophic loss of earning potential for the average worker in the Great Depression didn’t make even regular home loans impossible to manage. Instead, let’s look at what you said as a general concept.

    You are certainly right — the idea that interest-only mortgages are a way to “buy more than you normally can” or “leverage your future earnings” is just flat-out rabid consumerism. To that extent, interest-only mortgages can be the rope which you hang yourself with.

    On the other hand, there are certainly useful times for interest-only mortgages. It’s a great option for families refinancing who want to put money away now for a kid’s college — it allows you to pre-allocate about $12k over the course of 5 years to go into college funds, and in 5 years (when the kid is already in college), the higher payments shouldn’t phase you much. Yes, you could pull the money out in terms of a home equity loan when the kid goes to college, but then you’re A) looking at much higher payments overall, B) depending on rates to as low then as they are now, C) limiting your potential earnings to $12k in 5 years as opposed to investing that money, and D) going to have to pay to get at that equity.

    It’s also a good method for people who buy a fixer-upper to buy some time to pay for the improvements. It works just like the people saving for student’s college, except the money goes into capital improvements instead of some return-generating fund.

    Note that both previous cases assume that the person getting the mortgage can afford the higher (post-reamortized) rate, and are choosing to use the difference between the interest-only and post-reamortized rate for some kind of fiscally sound reason.

    It’s arguably good for anyone who intends to sell before the re-amortization period arives, since the principal pay-off in the first few years is relatively minor, although the very cost of buying and selling the property makes me suspicious at the numbers compared to renting.

    I’ve also seen it used as a way to leverage a rental property’s value to generate cash flow, but that requires that when the interest-only period is up, the owner either A) has escalated rent to the

    And, of course, both interest-only mortgages and their scary cousins — negatively amortizing mortgages — are useful for flippers, who are happy to pay as much as possible at closing in order to keep their holding costs down.

    The problem is if there are large numbers of defaults at the same time (or near enough). Then this risk sharing could bring everyone down simultaneously.

    This, of course, is no different between regular loans and interest-only loans.

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