Ask Arnhim!

Editor: Please allow me a little space to ask Arnhim some questions.

NDP recently launched their manifesto and has exposed what they plan to accomplish once elected to government. There are a number of areas where more clarification is needed. Who is better placed to answer them than Arnhim? Everybody has been told to ask Ralph. I am asking Arnhim.{{more}}

NDP is promising to build low-income houses, a significant departure from their earlier modus operandi: they gave building material to the poor. Under this new plan homeowners will save over $140,000 on mortgage payments. On the face of it, it seems a great vote-catcher. However, it raises a number of questions about its feasibility.

What are the problems faced by low-income home-owners under the current dispensation? According to Arnhim, homeowners borrow money from the banks, hand over the money to the Housing Authority, who, in turn, hands over a completed home. Some houses are long overdue, incomplete and homeowners broke. Could it be that the loan amounts were inadequate rather than, as NDP is insinuating, misappropriated? NDP is claiming that some of these homeowners have been dealt a double blow: paying mortgage and rent at the same time. Poor souls!

Arnhim promises a different source of funding for homeowners in the low-income bracket. Will you please tell us the source(s) of funding you have in mind or have engaged. Is this source a charitable institution? Is it a grant-fund source? Will these funds be at concessional rates and terms?

Or, is government the source of funding? Will the formal banking system provide funds at competitive rates? These and other questions beg answers.

What else is new about NDP’s approach? “There will be an administrative fee to cover the government’s cost for building the house.” What is this administrative fee? From the example given, one can deduce that it is the selling price of the house less the cost, $20,000. Will this administrative fee be the maximum possible? Will it be the same for five-year, 10-year, or the 30-year terms? If the answer is yes to all, what rates of interest will be applicable to the above terms to guarantee the administrative fee of $20,000? What, then is the administrative fee, if it is not the horizontal summation of interest payments over the term of the loan/mortgage? Will the Housing Authority be the financier in this case? If so, will it not source funds from somewhere and then relend to homeowners? Will the spread between the two rates be sufficient to lend low and long to make the Housing Authority a going concern?

What interest rate will ensure the $20,000 administrative fee and at what term? A loan/mortgage is normally compounded half-yearly, but has 12 monthly payments. Hence, it is the effective interest rate that matters in financial decision making. This interest rate is the price of borrowing and is a reflection of money market information, i.e. risks of one form or the other. The term, the duration of the loan, also impinges on the interest rate. Arnhim, just like all of us, seems to have horror with the size of interest payment and the repayment quantum. He has reason to be concerned because we are all faced with the awesome power of compound interest. It is the means by which financial institutions make money.

I now examine the $70,000 loan Arnhim proposes to cap at $90,000, and not $240,000. Arnhim is proposing a very short time to pay for the house, but a much smaller sum of money to be paid. I take his cue and use a five-year term, or 60 months for a loan/mortgage. What interest to apply? I use an effective interest rate of five per cent compounded semi-annually and derive a monthly payment of $1,483 at a monthly interest rates of 0.0082 per cent. The book value, due to rounding, is just around $89,000. It is close enough to justify the point.

Can a real low-income family afford the repayment of almost $1,500 per month and still live a fairly decent life? Not even the banks will impose such a burden on a customer after doing their evaluations. They will tailor their repayment to the customer’s ability to pay. Hence, borrowing short is not a feasible option for low-income homeowners. Do you really know the disposition of low-income people?

What will be the better option for a low-income homeowner? Obviously, a longer term and a lower repayment. I extend the analysis to a 10-year loan, assuming the same effective interest rate of five per cent compounded semi-annually. A monthly repayment of $846.18, at .0066 per cent. The book value of this loan is $101,542. Interest payment amounts to $31,542. It is this growth in interest and debt that frightens us off, but it is the nature of the beast called compound interest. To the borrower, it is a scary beast; but it is a lucky charm for the lender. This is the domain of mathematics and is often outside of the toolkit of the politician.

Financially, will the low-income homeowner be able to afford this lower repayment? If not, he may have to extend the term at the expense of higher debt in the future. By then, the interest payment may double or treble. Have you ever wondered why Maynard Keynes in his famous GT postulated the ‘euthanasia of the rentier’? We simply hand over our entire being to the rentier class.

NDP’s offer of lower payment on low-income loans might only be viable at a below-market rate and financed from grant or concessional funds at very short term. The borrower will pay back high for a short term. How many low-income homeowners will be able to own a home under this new approach? Ask Arnhim.