Houses for Veterans--No Cash Down

VOLUME 177

NUMBER 6

JUNE, 1946

89th YEAR OF CONTINUOUS PUBLICATION

by BRENDON SHEA

FIFTY or sixty hours a week on the assembly line, with extra pay for overtime, enabled the war worker to amass savings far in excess of anything he had been able to salt away before the war. Under the constant pressure of the payroll-deduction plan and the eight drives, even if he had no other savings, he had his war bonds. When peace came and he decided to buy a house, he was in a position to make a 20 or 30 per cent down payment. He could then get a mortgage for the balance.

But GI Joe’s pay did not compare with that of the war worker. His wife and children had all they could do to get along on his allotment. He had no chance to tuck away a tidy sum with which to take his family into a home of their own on his demobilization. Consequently, the loan guarantees in the GI Bill of Rights were provided, to enable the veteran to go into the real-estate market on an equal footing with the war worker.

With the urgent demand for houses, prices have skyrocketed. For example, in an old section of an Eastern city, a two-family house, poorly built in the late twenties, which sold in the middle thirties for $4000, sold recently for $7600, In some of the newer sections, where houses built during the thirties sold for $6500 and $7500, prices have now jumped to $10,000 and $12,000 and even higher.

In one residential section built up during 1939 and 1940, small singles of five and six rooms, which sold for $4500 to $5200 and were considered no bargains at the time, today are priced by one operator at $9300 to $9800.

A new four-room house in which a family of three would be overcrowded costs $6900. In spite of the fact that it is practically thrown together, and that linoleum is used to cover the softwood floors, because of the scarcity of oak flooring, such a house is sold before it is completed. Before the war a similar house could be bought, with hardwood floors, for under $4000.

A five-room house costs anywhere from $8000 to $9500 in the Northeast — the same type of house that would have been idle for many months during the late thirties priced at $4500 to $5000.

Some of the SIXor seven-room houses are in the luxury class today. In one new development in a large Eastern city, prices of by no means spacious six-room houses, with tile bath, tile kitchen, extra lavatory and garage, begin at $15,500. The prices of houses with one additional room the size of a large closet, and an additional bath with stall shower, — seven-room houses, — begin at $18,000. A few years ago the same type of house sold for $7500 to $8500.

The intent of the loan guarantees for veterans is certainly laudable. It would hardly be right if a young man who had spent four or five years in the armed forces had to wait another four or five years before he could purchase a home.

When the loan-guarantee section of the GI Bill was passed, it was hailed as a great boon to the veteran. Where it was possible for the war worker to buy a house for $10,000 with a down payment of from $2000 to $4000, a veteran could now buy the house for $10,000 with nothing down. To the veteran, the loaning institution lends $2000 to $4000 more than it ordinarily would. The money does not come from the Veterans’ Administration or the government, but from the institution which is making the loan. The Veterans’ Administration becomes a guarantor on the note up to the amount of $4000 — in the case of a $10,000 loan, 40 per cent, a proportion which remains constant over the life of the loan.

Copyright 1946, by The Atlantic Monthly Company, Boston 16, Mass. All rights reserved.

The loaning institution is safe whether the homebuyer is a war worker or a veteran. If the war worker pays down $2000 on a $10,000 house, the loan amounts to $8000; if the veteran buys a $10,000 house, the additional $2000 which is advanced over the recognized margin of safety is guaranteed by an agency of the United States government.

The bill further stipulated that on no loan guaranteed by the Veterans’ Administration should the rate of interest exceed 4 per cent; if it did exceed that rate, the guarantee would become null and void. As a safeguard to the veteran, the bill also stipulated that the Veterans’ Administration should choose a real-estate expert from its list of approved appraisers to certify to the value of the property under consideration. If the appraiser decided that the price was excessive, the Veterans’ Administration would refuse to guarantee the loan. If, however, the appraiser certified that the price was fair, the loan and guarantee would be approved.

The only outright gift to the veteran was the first year’s interest on the guaranteed portion of the loan — in the case of a $4000 guarantee, $160. Furthermore, the guarantee was limited to 50 per cent of the loan or $4000, whichever was smaller. In the case of a $2000 loan, the guarantee would be $1000.

2

IN the original bill the maximum guarantee was $2000. Amendments have increased it to $4000. The maximum term of twenty years in which to repay the loan has been increased to twenty-five. Instructions to the appraiser have been amended so that he is to certify to the “reasonable value” of the property rather than to the “reasonable normal value.” Such a distinction may seem technical and academic, and perhaps it is. Yet these three changes tend to make the GI Bill of Rights not only a definite step toward inflation, but a good boost to inflation. While making it easy for the veteran to buy a home at the moment, the provisions also make it easy for him to assume a financial burden beyond his ability to carry.

There is a further unfortunate economic factor in this picture. The various savings banks, commercial banks, savings and loan associations, insurance companies, and other loaning institutions have during the past few years acquired more cash and government bonds than they ever held before. In such portfolios there are some short-term certificates and longer-term marketable issues which can be readily turned into cash as the mortgage market opens. The liquidity of these institutions surpasses anything heretofore known. As a result, cutthroat competition has developed in the small-home mortgage field. In one of the Eastern states, conditions prompted the proposal of a Fair Practices Law, in an attempt to curb the unethical methods by which otherwise reputable banks were stealing mortgages from one another.

So the veteran finds many of the loaning institutions in his community willing to make him the loan he wants, even if it is excessive. Let us analyze the specific case of a veteran purchasing a $10,000 house. This figure may seem high, but in some parts of the country a good, single, fiveto sevenroom house, ten to fifteen years old, in a desirable section, will cost at least $10,000.

The veteran picks his house, goes to the bank, and applies for a loan of $10,000 to cover the full amount of the purchase price, offering as additional security the $4000 guarantee which is given him under the GI Bill of Rights. When the investment committee of the loaning institution visit the property, they will see a house on which, eight or ten years ago, when $7000 might have been the sale price, they would have hesitated to loan $6000.

Under the original terms of the GI Bill, which provided only a $2000 guarantee, they would have felt that a $10,000 loan on such property was too liberal. But with the government guaranteeing up to $4000, leaving a “net” mortgage of only $6000, the loaning institution is all too likely to acquiesce. It is just as safe for the institution to make a loan of $12,000 today with a $4000 guarantee as it was to make a loan on the same house of $10,000 with a $2000 guarantee as originally provided in the GI Bill. And that is the crux of the inflationary nature of this $4000 “benefit.” It allows the veteran to pay $2000 more for the same house, and the institution can lend $2000 more at no greater risk.

The device which was originally designed to protect the veteran from paying too much for his house was certification of the value of the property by an approved appraiser. For the first few months, the Veterans’ Administration specified the name of the appraiser on the Certificate of Eligibility when it was returned to the intended mortgagee. Later, because of complaints that this system materially slowed up the process, loaning institutions were allowed to choose their own appraisers from a certified list issued by the Veterans’ Administration.

Under the provisions of the original bill, the appraiser was to specify the “reasonable normal value” of the property. That was not intended to mean the market value as of the current period, but rather the reasonable value of the property under normal conditions. The appraiser’s value of the property would be set above the low price level of the middle thirties and yet not so high as the inflated price levels of today. Now, with the word “normal” removed from the regulations and merely the “reasonable value” required, it is apparently assumed that the appraiser will float upward with the balloon of inflation. If the appraiser does not certify that the property is worth the loan that the institution has approved, he will probably lose a client, since the institution can choose its own appraiser.

Evidence of collusion between loaning institutions and appraisers is already obvious. Some of the more conservative appraisers, who had appraised properties below the sale price, have reported that they are getting fewer and fewer calls.

Another consideration often overlooked is the veteran’s ability to carry the monthly payments. Although he can buy a house without a down payment, the veteran is still at a disadvantage. He is assuming more substantial monthly payments just because he has a larger mortgage. The war worker who purchases a $10,000 house, and who carries an $8000 mortgage, at the rate of 4 per cent pays $48.48 per month, principal and interest, on a twenty-year term. The veteran’s monthly payments on the same house with a $10,000 loan would be $60.60. If, because of the rising real-estate market and the $4000 guarantee, the veteran pays $12,000 for the same house and obtains a loan for the full amount, his monthly payments are $72.72, or 50 per cent more than the $48.48 payment on an $8000 loan. To all the above amounts must be added a monthly allowance for taxes, insurance, water, and repairs.

Originally limited to a twenty-year loan, the veteran now has the option, with the consent of the loaning institution, of a twenty-five-year mortgage. This would reduce his monthly payments on a $10,000 loan from $60.60 to $52.79 — less than $8.00 a month for a difference of five years. He may well consider the amortization schedules of these longer periods.

On a twenty-five-year mortgage, at 4 per cent interest on $10,000, payments of principal and interest total $52.79 per month. On the amortizing, directreduction mortgage the interest is figured each month on the unpaid balance, and the difference between the interest charge and the above figure is credited to the loan. In this particular instance, $33.33 would be credited to interest the first month and the balance of $19.46 credited to principal. These monthly payments, credited on the loan over the entire life of the mortgage, eventually amortize the loan. On a twenty-five-year term, three hundred such monthly payments will finally pay off the mortgage. In other words, the homeowner by his monthly payment is purchasing just a little more equity in his home each month, while at the same time he is paying the interest on the amount that he still owes.

The danger, however, of the long-term loan is the very slow amortization schedule. For example, at the end of one year, on a twenty-five-year loan only 2.4 per cent of the mortgage has been paid off. The twenty-year loan is almost as bad, with only 3.3 per cent of the principal paid off at the end of one year. At the end of three years, 7.4 per cent has been paid off on the twenty-five-year term, and 10.4 per cent on the twenty-year term.

The following table shows balances due on $1000 at 4 per cent after a given period: —

It is often argued by the proponents of this type of mortgage that as long as the homeowner keeps up his monthly payments, the mortgage will eventually be amortized, and after twenty or twenty-five years the couple who bought a house at twenty-five or thirty have at fifty or fifty-five a home which is free and clear. But such reasoning ignores changes in the economic cycle, and the contingencies which may arise in a tenor fifteen-year period, let alone a twentyor twenty-five-year term.

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How much higher the prices of houses will rise, no one can say. Once the building program is rolling, however, houses will be built until the saturation point is reached and the supply surpasses the demand. Let us say that in five to eight years there is a slowdown in the building program, accompanied by a slowdown in industry as well. At that time, with houses availabletis they were during the middle thirties, when new dwellings stood idle a year or two, prices certainly will not remain at peak levels.

Now let us look at the financial status of a homeowner who bought a house, with no payment down, for $10,000 on a twenty-five-year mortgage. Taking into consideration the fact that the value of his house may have increased an additional 10 per cent, so that the value is $11,000 when we hit the peak, there is, let us say, a 40 per cent drop in prices. Where does that homeowner stand? He has a house that is worth $6600 on the current market. If it is eight years from the day he bought it, his twenty-five-year mortgage has a balance of $7800 — $7800 due on a house worth $6600! If he has a twenty-year mortgage, the balance will be $6920 on a house which has a market value of $6600.

The veteran who buys his house, let us say, six years from now, and two years before the hypothetical slump, will find that his $10,000 house which he bought at the peak, if it drops in value only one third, is worth $6700. If his twenty-five year mortgage has run for two years, he will owe $9515, and if it is a twenty-year term, $9320 — $9320 due on a $6700 house!

If he is one of the more fortunate and continues his job without a reduction in wages, he will not enjoy the necessity of continuing payments on a mortgage which will be in excess of the current value of his property; and if he should run into difficult times because of a temporary, or possibly permanent,’lay-off in his job, how much heart will he have to keep the house when he knows that the encumbrance on it is far more than the house is worth? It will certainly seem to him like pouring money into a bottomless pit.

If he is unable to continue his payments and the loaning institution, with the consent of the Veterans’ Administration, forecloses, there is little, if any, loss to the loaning institution, because the guarantee continues at the same percentage during the life of the loan. But what of the losses sustained by the Veterans’ Administration, which in the long run have to be paid by the United States — made up of the veteran, the loaning institution, the landlord, the tenant, and you and me? Of course, once the Veterans’ Administration pays a loss under a guarantee, it acquires a claim against the veteran which it can press at any time the veteran is in a position to pay; and if the claim is not collected during the veteran’s lifetime, it becomes a claim against his estate.

There is one other aspect of the amortization of long-term mortgages that needs consideration: the percentage of mortgages paid off prior to maturity averages over 80 per cent. The loan may be paid off because the property is sold and the purchaser requires a different loan or pays cash. Sometimes the homeowner finds it convenient to refinance the mortgage. He may want to send his children to college. He may have to pay for an expensive illness. Or he may wish to finance repairs or renovations: add a room or two, reshingle the roof, paint the outside, make interior repairs, renew the heating system or the plumbing, or do some of the numerous things a house needs every few years to maintain its value. Such repairs come under the general classification of “upkeep.” Institutions which finance home mortgages find that it is the rule rather than the exception for the homeowner to refinance the mortgage whenever he wants to make substantial repairs.

And where is the veteran going to be when, five years after the purchase of his home, he tries to borrow $500 to make repairs? He will have paid off $1290 on a $10,000 loan on a twenty-five-year term, or $1800 on a twenty-year term. His more astute neighbor who has a twelve-year loan will have paid off $3600, and the man who has a ten-year loan, $4500. Assuming a stationary market value over the period, the homeowner with the short-term mortgage and large equity is much better off than the owner with the long-term loan and little equity. And when a slump comes, the man who has tangible equity can draw on it to make necessary repairs or to meet other contingencies.

This discussion is not intended to disparage the benefits allowed under the GI Bill of Rights. The premises on which those benefits were based were sound. The danger lies in overburdening millions of veterans whose lack of experience makes them easy prey to what seem attractive offers. Excessive loans, lengthened terms, and overselling at high prices can only lead to a disaster greater than the depression which began in 1929.

The loaning institutions, the appraisers, and the Veterans’ Administration should move cautiously, and should not make indiscriminate loans. A boy of twenty-two who got his first job two months ago is in all probability not prepared to buy a home. He may never have worked before, never have had any financial responsibility, never known what home ownership entails. And yet, hearing of the benefits and privileges due the veteran, he may blithely attempt to buy a home with a 100 per cent mortgage.

Above all, the veteran himself should tread carefully. While taking every advantage of the assistance to which he is entitled, he should make sure, first, that he understands the transaction he is undertaking, in all its aspects; and second, that it is the best thing for him to do. It may be that he is not yet prepared for home ownership and its responsibilities, and therefore would be better off to wait for a few years. At times the tenant is in an enviable position; and the too hasty purchase of a home can turn out to be financially disadvantageous or even disastrous to the owner and his family.