To help more people afford homes, there is talk of a new 40 year mortgage product. This of course would not help who it is supposed to.
Home prices are more expensive than ever. Mortgages rates are at a 40 year high.
Income inequality means that while more money flows to the richest among us, wages in U.S. homes continue to stagnate.
So it’s not surprising that people are feeling hopeless about being able to own a home. They feel like it’s too late, that the train has pulled away from the station.
I don’t necessarily share that concern, but then again, I don’t believe that buying a home is always a good idea, nor do I believe that it’s the only way to achieve wealth.
With all this as a backdrop, I was chatting with a colleague the other day, and she told me about a new mortgage product she had heard about that I had apparently missed.
It was called, without any need to embellish it: the 40 year mortgage.
Rarely am I rendered speechless, but it took me a minute to pull my jaw off the floor.
Because rarely has something seemed so ridiculous, and yet so inevitable at the same time.
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Long-term fixed-rate mortgages are common (but only in the U.S.)
It was surprising to me to learn that long-term fixed-rate mortgages are actually quite rare around the world. Most places have a fixed term for only a few years before the interest rates float and change with the times.
This actually makes sense for the lender. Long-term fixed-rate mortgages are a really good deal for the borrower but not the lender. And while rates can go down, leaving the borrower stuck with a higher-than average rate, there’s a floor to how low mortgage rates can go (0%) but no ceiling, a fact that may feel worryingly poignant these days.
Long-term fixed-rate mortgages are not such a great deal
But a good deal on rates is offset by an absolutely terrible deal on the actual mortgage.
In reviewing a financial decision, it’s always best to look at how much something costs overall, and not how much something costs per month.
And in this way, a 30 year mortgage gets destroyed by even a 15 year mortgage.
I did some math so you don’t have to: If you pay off a $300,000 mortgage at 6% interest over 15 years, it will cost you $455,683, while if you have the exact same mortgage paid off over 30 years, you’ll pay $647,516, a difference of almost $200,000.
And this is exclusive of exclusive of things like PMI, which will cost you even more over the 30 year term.
It gets even worse, because, assuming the same 10% down payment on each home in this example, it’ll take you 7.5 years to build 10% equity in your home, versus 2.5 years in the 15 year mortgage.
So if you sell before you pay the home off, you’ll have that much less to show for yourself.
Enter the 40 year mortgage
Recently, news came out that the Federal Housing Administration has greenlit 40 year mortgages.
What would a 40-year mortgage do in our $300k example above?
Well, you would pay an eye-watering $792,309 over the life of the loan, and it would take you over 12 years to get a measly 10% equity in your home.
Now, of course, that’s not why people would be interested in such a product. They would want it because it would lower their monthly mortgage payments.
And yes, I get that mortgage payments are high now. No need to debate that. And I recognize that while you should look at how much something costs overall, if you can’t afford it in the moment, it doesn’t really matter. (This is why most people don’t pay cash for a home, even though that’s by far the cheapest.)
But let’s look at the monthly numbers here, just principal and interest for now. Given our $300,000 example home above:
- For a 30 year term, it will cost $1,799 a month.
- For a 40 year term, it will cost $1,651 a month.
That’s only a difference of $150 a month! Come on people! If $150 is all that’s standing between you and foreclosure, you’re playing way too close to the cliff-edge anyway!
It’s not even a huge benefit to you as a borrower. So who is it a benefit for?
Who benefits from a 40 year mortgage?
“‘If it helps people get into a house, it’s a good thing,'” Sonsire Gonzalez, a real estate agent in Port St Lucie, said.Source: WPTV West Palm Beach news report
And that tells you pretty much all you need to know. A 40 year mortgage doesn’t benefit you, but it does benefit real estate agents and mortgage brokers.
How? The real estate agents get access to more potential buyers, and the mortgage brokers make way more money on their loans.
And you, by virtue of how they have sold owning a home to us as the American Dream, are sucked into throwing your financial life away with one of these horrible products.
One more thing: if you were to take out a 40 year mortgage today, you won’t have paid it off until 2063. Let that sink in.
40 year mortgages might not exist (yet)
Now, the announcement above was just regarding a mortgage modification, not mortgage origination. As MarketWatch notes, you can’t get a 40-year mortgage now.
But that could easily and quickly change. And I would fully expect this product to be available within the next few years, if not sooner. And who knows how long it’ll be before 40 years are more commonplace?
After all, it’s much easier to sell people a story that they “need” to own a home than it is to build more housing, which would in turn bring down the cost of homes for everyone.