Betting on the financial illiteracy of Americans has historically been a profitable endeavor for the powers-that-be, so it should come as no surprise that an idea to introduce 50-year mortgages is being talked about right now. It has been proposed as a way to make home buying more affordable, which is a dubious assertion at best. I shouldn’t have to tell anyone it’s a bad idea, but here we are. It’s a bad idea. Here’s why.
Math. Assume you’re buying a home and your loan amount is $500k. At present, you’re probably going to take a 30-year conventional mortgage, which is the most common loan instrument you can take. The interest rate on that loan right now is about 6.3%. Your monthly payment will be $3094, and after thirty years when the house is fully paid off you will have paid $1.14 million in principal and interest. That’s no small number, but just wait.
Now let’s run those numbers for a 50-year loan. It’s safe to assume that the interest rate will be higher for this loan than for a 30-year loan, in the same way that the rate is higher for a 30-year loan compared to a 15-year loan. So, let’s take a stab at it and say the rate for the 50-year is at 6.75%. Your monthly payment is $2913, so about 6% lower than with a 30-year loan. However, by the end of the loan, the total of your payments equals about $1.75 million. In other words, you’re paying twice as much interest on this loan compared to the 30-year, and your interest payments will be 2.5x the cost of the home itself.
There’s more. Most people don’t hold their mortgages for fifty or thirty years– in fact, the median rate of homeowner tenure is about twelve years. When it comes time to sell, it’s critical for move-up buyers to have some real equity to help make that move. Price appreciation will hopefully account for some of the equity, but reduction in principal will also be a factor. After twelve years, someone with a 30-year loan will have paid down the principal on that $500k house by about 20%. That’s a cool $100k in increased equity that can go to the new house. With the 50-year loan, about 4% of the loan has been paid off after twelve years. $22k on a $500k house. In that time, while you’ve reduced the principal by a whole $22k, you’ve paid nearly $400k in interest, money that just went poof.
If it doesn’t particularly benefit home buyers, as it’s being sold, who does it benefit? Follow the money. Lenders make a lot more money of course, but the other entities it benefits are institutional investors, who care less about long-term interest than typical homeowners. They can now purchase homes at a lower monthly price and realize higher cash flow when they rent them out. That makes the prospect of further reduced supply of homes for sale a real one.
Let’s call this 50-year mortgage what it is– renting, but you have to replace your own roof. You get the warm and fuzzy feeling of being a homeowner but without getting any of the tangible benefit of being a homeowner. Saving $181 a month is going to look very attractive to many buyers, but the true cost is financially devastating.
Any idea to help affordability without addressing supply– the real issue– is doomed to fail. Giving credits or incentives to buyers sounds great, but really only increases home prices. Lowering interest rates increases home prices, which we saw in dramatic force a few years ago. Stretching out mortgages to fifty years will likely increase home prices too, erasing any improvement a buyer gains on their monthly payment. Supply of new homes, which has been lagging for a decade, needs to catch up to demand, and it really is as simple as that. Anything else is a gimmick.
