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The 2/28 Game

posted by Elizabeth Warren

The New York Times ran a front page story yesterday about re-refinancing. Families now facing the end of the teaser rates on their adjustable-rate mortgages can’t make the payments when the rates re-adjust, so they are taking out another adjustable rate mortgage—with another teaser rate. They stay alive for another two years. And what happens when that one comes due? Evidently they are following the Scarlet O’Hara plan to worry about that tomorrow.

The obvious problem is that if housing prices level out, these families will have no options at all. No more teaser rates because the value of the home won't back up the mortgage.  They will have rented homes for two years or four years that they could not afford, and they will lose everything they invested and more. If the amount owed on the home is more than the outstanding loan balance when the music stops, the homeowner will face bad credit ratings and bankruptcy.

The Times article does not emphasize how expensive this re-refinancing is. Closing costs and fees all get lumped back in to increase the outstanding balance. Keep in mind that these buyers couldn’t make market-based payments on the old, lower balance. The odds of making those payments on the new, higher balance are worse than those in any Las Vegas gambling parlor.

In the industry, these mortgages are called 2/28s. The numbers refer to the teaser period (the 2) and the real payout period with the higher-than-market interest rates (the 28). How can the “2” be profitable for the lender, if the debtor re-fi’s the loan without paying the high 28 period? Many of these loans carry a pre-payment penalty, along with up-front fees and closing costs that make them instantly profitable. Even if the debtor refi’s immediately, the amount paid off includes all these costs, making the effective interest rate for the “2” ten or twenty times higher than the stated interest rate.  In the 2/28 game, the lender nearly always wins.

Could re-refinancing be the knife that will cleave what is left of the middle class?  There will be those who have fixed-rate mortgages, who pay off their homes, and who have something for retirement or savings if a catastrophe hits.  And then there will be those who live in houses, paying high rent, always vulnerable to rate hikes, flat real estate markets, job layoffs, etc.  That last group will nominally be called "homeowners" just like the first, but they won't really be.  They will play the 2/28 game until they go bust.


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