The 50 Year Mortgage Mirage

The recent proposal to extend home mortgages from 30 to 50 years has the superficially appealing notion of reducing the cost of home ownership and, specifically, making it easier for first-time home buyers to purchase a home.

Nothing could be further from the truth.  While the average person might conclude that their mortgage payments would be about 60% of those at a 30-year term because they had so much time to pay, the fact is that there is almost no monthly savings benefit to buyers of terms longer than 25 to 30 years.  The interest rate dominates the equation, and longer terms always mean higher rates.  That is why the lure of adjustable-rate mortgages traps so many.

You can look at this yourself using XCEL and the “pmt” function, which has explicit variables of interest rate, term, and principal, and you will see the following. Here are the numbers for a $300,000 mortgage at 30- and 50-year terms, assuming a 6% interest rate. Remember that first-time home buyers often must have others co-sign because lenders are uncertain they can repay the loan. Leave that aside right now.

The 50-year mortgage would be $1,579 per month, which is only about 14% lower than the 30-year mortgage at $1,799. Small differences like this don’t change the lender’s perspective on the buyer. If you can’t afford the $1,799 you probably can’t afford the $1,579.

Or think about it from the lender’s perspective.  The monthly savings would only allow the lender to lend about $8,000 more for the value of the house!  And, the lender has more risk with the 50-year term, so the likelihood is they would raise the interest rate. If they raised it by 1% it would wipe out any benefits to the borrower. 

What really makes the 50-year term absurd is the total payments perspective. A 30-year mortgage at the rates would be just a bit less than $650,000. The 50-year mortgage would total over $1,00,750! That is more than $400,000 than the 30-year mortgage!! Smart buyers learn to pay off their mortgage along the way by doubling the payment specifically to reduce the cumulative effect of the interest rate.

The fundamental reason home ownership has become “unaffordable” is that the amount lenders will lend on a home is generally only 2-3 times the annual salary, and they have always tended to discount the female in a couple’s combined salaries because there is the likelihood they will have children and then choose not to work.

Risks are real in life and lenders generally understand that. The reason we had the bank collapse about a decade ago was there were absurd financial instruments in place that gave lenders the feeling they could “lay off these risks” and the result was that people were getting mortgages way beyond the 2-3 times annual salary guideline. We all know what happened when these risky derivatives imploded. Remember the phrase about banks being “too big to fail?”

The base problem with today’s housing market is a supply problem. We need to build starter houses specifically for this market, and I believe many builders now recognize this, specifically with very small house designs … which are really cute.

While I can appreciate leadership looking for creative ways to address this problem, my conclusion is that it will not pass financial scrutiny to be realistic. The idea that a 50-year mortgage term solves the problem is a mirage.

Sorry.  Superficially appealing notions are always like this.