Financing Affordable and Sustainable Homeownership with Fixed-Cofi Mortgages

54 Pages Posted: 8 Feb 2018 Last revised: 29 Apr 2020

See all articles by S. Wayne Passmore

S. Wayne Passmore

Board of Governors of the Federal Reserve - Household and Real Estate Finance Section

Alexander von Hafften

Board of Governors of the Federal Reserve System

Date Written: 2018-02-05

Abstract

The 30-year fixed-rate fully amortizing mortgage (or “traditional fixed-rate mortgage�) was a substantial innovation when first developed during the Great Depression. However, it has three major flaws. First, because homeowner equity accumulates slowly during the first decade, homeowners are essentially renting their homes from lenders. With this sluggish equity accumulation, many lenders require large down payments. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowners might have better uses for this money. Third, refinancing mortgages is often very costly. Expensive refinancing may prevent homeowners from taking advantage of falling rates.{{p}}{{p}}To resolve these three flaws, we propose a new fixed-rate mortgage, called the Fixed-Payment-COFI mortgage (or “Fixed-COFI mortgage�). This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and does not require a down payment. Also, unlike traditional fixed-rate mortgages, Fixed-COFI mortgages do not bundle mortgage financing with compensation paid to capital markets investors for bearing prepayment risks; instead, this money is directed toward lower monthly payments or toward purchasing the home. The Fixed-COFI mortgage exploits the often-present prepayment-risk “wedges� between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. In addition, the Fixed-COFI mortgage is a highly profitable asset for many mortgage lenders.{{p}}{{p}}We discuss two variations of the Fixed-COFI mortgage. Homeowners with “affordable� Fixed-COFI mortgages are rebated the “wedges� between the traditional fixed-rate mortgage payments and the COFI mortgage payment. After the “wedges� are rebated, these homeowners may pay substantially less to purchase their homes in 30 years than homeowners with traditional fixed-rate mortgages. This mortgage design may help alleviate housing affordability pressures in many areas of the United States.{{p}}{{p}}The other variation of Fixed-COFI mortgage is the “homeownership� Fixed-COFI mortgage. With the “homeownership� Fixed-COFI mortgage, the homeowner commits to a savings program based on the difference between fixed-rate mortgage

Keywords: Downpayment, COFI, Fixed-rate mortgage, Cost of funds, Homeownership, Interest rates, Mortgage

JEL Classification: G01, G21, G23, G28, R28, R30, R38

Suggested Citation

Passmore, Stuart Wayne and von Hafften, Alexander, Financing Affordable and Sustainable Homeownership with Fixed-Cofi Mortgages (2018-02-05). FEDS Working Paper No. 2018-009. Available at SSRN: https://ssrn.com/abstract=3120333 or http://dx.doi.org/10.17016/FEDS.2018.009

Stuart Wayne Passmore (Contact Author)

Board of Governors of the Federal Reserve - Household and Real Estate Finance Section ( email )

Washington, DC 20551
United States
202-452-6432 (Phone)
202-452-3819 (Fax)

Alexander Von Hafften

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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