Forty year mortgages: credit boon or debt bust?
The defining characteristic of middle class status is home ownership. Why? Because paying down a mortgage while a home's value appreciates has always been the safest way to accumulate wealth. Today, home ownership is also a proxy for access to above-average public education.
Historically, the Federal National Mortgage Association (better known as Fannie Mae) has purchased thirty-year mortgage loans as part of its mandate to maintain a market for these mortgages and ultimately help more families into homeownership. It recently decided to purchase forty-year mortgages as well.
What does this mean for the American middle class? On the positive side, it means more access to mortgage money. Every person who buys equity in a home is a potential stable member of the middle class. We want to encourage that.
But what about the dark side? It is heresy to raise questions about whether more access to mortgage money – and hence to homeownership – is good, but a 40-year mortgage means that it will take a lot longer for people to build real wealth in their homes. A higher proportion of mortgage dollars will go to interest, and a homeowner faces another decade of debt. At some point, these new mortgage products shift the balance so that taking out a mortgage looks a lot more like renting property than buying it.
The specific mortgage issue you raise (40 year mortgages) just adds to the problem. It's one of a host of problems with the current mortgage boom:
1. Mortgages are too large--people are buying homes that cost more than they really should be spending (if you are borrowing more than 2 to 3 times your annual income to purchase your house, you are in danger of spending more than you can afford).
2. While refinancing at a lower interest rate makes sense, too many Americans are lengthening their mortgages when they refinance and are borrowing more money at the same time--these two latter changes to their loans usually outweigh the advantage of the lower interest rate, resulting in larger overall finance charges. I've seen a lot of people who go into a refinancing with say $100,000 in outstanding debt at 7% interest and 20 years left to pay it off and come out with $150,000 in outstanding debt at 5% interest (variable rate) and 30 years to pay it off. What they don't clearly understand is that before refinancing they were going to pay the bank about $186,000 in the future and after refinancing (even if their variable rate doesn't increase) they are going to pay the bank about $290,000. If they now take a 40 year mortgage instead of a 30 year, they'll pay the bank a whopping $347,000--and that's assuming the 5% interest rate doesn't rise, which is unlikely over 40 years.
3.Too many mortgages are at variable rates that will likely rise in the future, increasing the cost of all this debt.
4.While rates are historically low, they are not as low as people think when compared with current returns on stock and bond investments. When investments are returning 2% per year, a 5% interest rate is not low.
5. The long terms of many mortgages mean many people will still have outstanding debt at retirement. This is scary to me, since the fall-off in income at retirement makes paying a mortgage very difficult.
June 13, 2005 6:24 PM | Reply | Permalink
Given the current real-estate bubble, I'm interested in home-ownership and the mortgage market in general. After reading your post, I am wondering about of the demographics of the mortgage markets: (i.e.)
Is there a substantial difference in the demographics of owners of 30 and 40 year mortgages? (Are most forty-year mortgage holders first time homeowners, etc.)
Also, what is breakdown of the distribution of mortgages currently in the market? I always thought that mortgages were predominantly of 30 year duration. Will the decision by fanny-mae change the status quo substantially?
(I'm 20 years old, and have never even thought about owning a home, so excuse my ignorance and educate me please.)
A quick google of this stuff turned up nothing, by the way.
June 13, 2005 6:27 PM | Reply | Permalink
If I think I can handle a 40-year mortgage, a 1-5 ARM, an IOM, or any other damn financing scheme, I don't want some apparatchik telling me I can't.
June 13, 2005 6:53 PM | Reply | Permalink
Try this.
June 13, 2005 6:56 PM | Reply | Permalink
You can do anything you want--it's a free country. No one said we should ban 40 year mortgages, just educate people about the significant risks of financing debt for such long periods. What scares me is that if we don't do that education (or if people don't pay attention), we'll end up with lots of broke, homeless people on the streets in 20 years and guess what--those people will want the government to bail them out. We could let them starve to death, I guess, but starving people often get violent. It could get real ugly.
June 13, 2005 7:13 PM | Reply | Permalink
I was practicing a bit of hyperbole. But I will admit the tone of this "Middle Class" blog often seems to me to be annoyingly patronizing and "nannyish."
From what I've read so far, the moderators have defined the Middle Class as a set composed of undisciplined profligate just-barely-making-it innumerates certain to be taken advantage of by anyone not employed in a university.
June 13, 2005 8:48 PM | Reply | Permalink
Ellen, without the aid of tone of voice, I couldn't decide if you were being sarcastic or were a serious Libertarian . . . so I decided to take you at face value.
Anyway, I'm all for personal responsibility in these matters--but I do worry about Americans being generally uninformed and doing things today that will lead to massive problems in the not-too-distant future. When I look at current government policy (for which I blame both Democrats and Republicans) and the personal choices people are making (with credit cards, mortgages, retirement savings, etc.), I am truly frightened. I worry we may be heading for a major financial crisis that could cause the country to come unglued.
June 13, 2005 9:18 PM | Reply | Permalink
A 30-year mortgage can be paid off during a working life with the prospect that the home will be owned outright during retirement. For most home-buyers, a 40 year mortgage means that payments will continue after retirement and the end of active income-earning. Many people are have are unprepared for retirement even without the prospect of mortgage payments until death. What they are counting on is continued high appreciation to permit the extraction of cash when time comes to retire. This turns home ownership into gambling on appreciation rather than investing in a stable asset.
(Of course, repeated re-financing has the same effect, so maybe this horse is already out of the barn.)
June 13, 2005 10:04 PM | Reply | Permalink
<p>It's not so much whether forty-year mortgages should be available, but whether Freddie Mac should be buying them.</p><p>And no, clearly not. </p>
June 13, 2005 10:21 PM | Reply | Permalink
After what happened with bank dereg mess on Texas and what's been going on with contracts in Iraq, you can bet there's some rw cronies that are raking in big money from scamming, profiting from and basically scamming from ordinary people who will end up the victims losing everything and being screwed in the end no doubt. It's a real shame.
June 14, 2005 1:20 AM | Reply | Permalink
I was unclear, sorry. I'm an not looking to buy a home (I can barely afford my books), I'm looking for information, preferably a survey of the mortgage market (i.e., the break down between the mortgages of different duration, amount of fixed vs. flexible interest rates, et cetera).
June 14, 2005 6:34 AM | Reply | Permalink
Ed, unfortunately I don't have the statistics you're looking for, but I'm going to guess anyway (take these guesses with a grain of salt, though, because they're based only on my casual observation, not any real data):
40-year mortgages are new so they are not common yet
30-years is probably the most common mortgage term, particularly for first-time buyers, but 10, 15, 20, and 25 year mortgages aren't rare, particularly when the buyer can afford a significant downpayment.
It used to be that almost everyone took a fixed rate mortgage, but now variable rates (of various sorts) are probably more popular than fixed rates. (I think this is true for all buyers and refinancers, not just first-time buyers.) A typical adjustable rate mortgage (ARM) will provide a fixed interest rate for 3, 5, or 7 years, then begin to vary annually or every 2 or 3 years. Most have some caps on them, so interest rates can't rise beyond the cap.
Traditionally, lenders required downpayments of 20% of the value of the house, but most first-time buyers probably put down less then 20% nowadays; no downpayment loans are getting more common. If you put less than 20% down, you may have to pay for mortgage insurance, which protects the lender if you can't meet your mortgage payments and you don't have enough equity in your home when the lender goes to repossess it.
Some new mortgages allow you to pay only the interest on your debt. I've never looked at these loans in detail, but it seems like your mortgage would extend indefinitely if you didn't pay any principal.
June 14, 2005 7:02 AM | Reply | Permalink
Ed, you also asked whether 40-year mortgages would become the standard in the future. I'm not sure, but since monthly payments will be lower with a 40-year mortgage than a 30-year, I'd expect them to become rapidly popular. The downside of extending the payment period, though, is that total finance charges over the life of the loan become quite high. You're paying off your principal very slowly with a 40-year loan.
June 14, 2005 7:06 AM | Reply | Permalink
Forty year mortgages may or may not be a problem. However, I don't think they are as big of a problem as interest only mortgages or ARMs with no down payment. That's what is going to ultimately pop these localized bubbles (East & West Coast). People also need to stop using their homes like cash machines.
June 14, 2005 7:53 AM | Reply | Permalink
First response: Ooh, Can *I* be your banker?
Second response, more carefully thought out: Borrow $100,000 at 6% for 30 years, or choose 40 years:
30 year, monthly: 599.55 * 360 = 215,838.00
40 year, monthly: 550.21 * 480 = 264,100.80
So the difference is ten additional years of payments in exchange for a difference of fifty bucks of principal pay-down per month at inception. Assuming you sell before the term of the mortgage, the difference is found in the rate at which you built up equity, which is useful in purchasing the new home.
Yes, *you* can handle whatever you want. I assume that you know the risks and rewards of your choices.
What I resent is too many marketers misinforming the people to whom they are selling their snake-oil. In response to a down-thread comment about "nannying", I've seen very smart people who are very preoccupied with their lives making very very very stupid decisions.
So, those of us who resent this stuff are not asking for new laws to prevent financial institutions from offering these choices. It is much more about demanding that financial institutions not mislead their listeners.
June 14, 2005 10:58 AM | Reply | Permalink
What is need are numbers and polls. If home buyers who would have purchased 30 year mortgages are taking the easy road or buying bigger homes are instead using 40 year morgages, then that is a problem. If individiduals who would have conitnued in the rent trap for longer, possibly the rest of their lives, are instead purchasing homes, then it is a positive.
My guess is that it is a little of both.
June 17, 2005 1:37 PM | Reply | Permalink