Friday, October 30, 2009

Borrowers' mantra: Can't refinance? Just stop paying interest.

Some recent numbers from the US treasury a showing a continuing decline in the total amount of interest paid on residential mortgages in the US. The question is what is causing the decline. The most obvious answer is the tremendous drop in mortgage rates in 09 as well as LIBOR or Prime linked short-term rates on floating rate mortgages. Luckily the Treasury provides us with some history of average rate paid on mortgages (see chart below.)

Given that mortgage rates are at around 5% (and short-term rates are even lower), why is the average rate above 6%? This says that a large proportion of the borrowers out there are unable to refinance.

The total interest payments have dropped 5.2% from the peak in Q2 of 08. The rate drop explains 4.1% of this reduction and some would say that the remainder can be explained by de-leveraging. But the bulk of that de-leveraging is not borrowers voluntarily paying down their loans. It's the defaults.

The chart below only goes to Q2, but it more than explains the reduction in interest payments.

source: Bloomberg

In fact the drop in mortgage interest payments would have been significantly steeper if it wasn't for new home buyers (taking out new mortgages, adding to the total interest paid). The answer these days to having too much debt seems simple - if you can't refinance, just stop paying the interest.
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