Wednesday, December 14, 2005

The 40yr mortgage...is it for YOU?!?!?

Why be knee deep in debt for 30 years, when you can do it for 40 years?!?!?

I'm sure many of you have heard about the latest and greatest "advancement" in the mortgage industry: the 40 year mortgage. These come in various forms: 2/38, 3/37, 40 year fixed, and 40/30 mortgages. The 40/30 mortgage is a "balloon" mortgage. The loan is amortized over 40 years, but a "balloon" payment is due for the balance of the loan in 30 years. You have to either pay it off, or refi the remaining portion. The 2/38 and 3/37 are your standard ARM mortgages that are fixed for 2 or 3 years, then adjust for the next 37 or 38 years. Sounds like fun doesn't it?!?!?

Now that we know the basic types of these loans, lets see how it hits the old pocketbook. I am going to compare the payments at different rates, using 30, 40 and 100 year mortgages. WHAT, a hundred year mortgage?!?!? Well, they aren't here yet...but in the effort to "keep homes affordable" we might see it in the future. I think you will be surprised with what you see in regards to the 100yr mortgage. You will see that even a 100yr mortgage does not lower payments that dramatically, especially for the money you will end up paying in the long run.

I am using 2 loan sizes that are "typical" in high value areas. Again, take the numbers for what they are worth. Look at the trends. Lots of things to go over here. Here are the numbers for a $400,000 and $800,000 loan at 30yr fixed, 40yr fixed, and 100yr fixed payments.

$400,000 loan at 5% 30yr fix = $2147.28 . . . . .total pmt = $773,023
$400,000 loan at 5% 40yr fix = $1928.78 . . . . .total pmt = $925,817
$400,000 loan at 5% 100yr fix = $1678.09 . . . . .total pmt = $2,013,709

$400,000 loan at 6% 30yr fix = $2398.20 . . . . .total pmt = $863,352
$400,000 loan at 6% 40yr fix = $2200.85 . . . . .total pmt = $1,056,408
$400,000 loan at 6% 100yr fix = $2005.04 . . . . .total pmt = $2,406,048

$400,000 loan at 7% 30yr fix = $2661.21 . . . . .total pmt = $958,035
$400,000 loan at 7% 40yr fix = $2485.72 . . . . .total pmt = $1,193145
$400,000 loan at 7% 100yr fix = $2335.50 . . . . .total pmt = $2,802,600

Whew, lots of things we can learn from these numbers. Let us look at some simple things first, like the impact of interest rates on things. Look at the 30yr fixed payment on the 3 loans. 5% is a pretty accurate fixed rate that wasn't that hard to get the past few years. Right now, rates are in the 6% range, and if you look at the projections, fixed rates around 7% could be here in 12-18 months. Many subprime/alt-a borrowers today are in the 7% range. That $2147 payment at 5% covers the mortgage at $400k. That same $2147 payment at 7% only covers a loan amount of $322,710 !! That is a 19.3% drop in buying power, with just the rate going up 2% from 5 to 7%.

Let's see if the 40yr mortgage would help us here. Let's keep the same $2147 payment, but lets do a 40yr loan at 7%. The same payment on a 7% 40year loan only covers the mortgage on an amount of $345,492! That is still 13.6% short of what a 5% loan on a 30yr fixed did just a year or so ago!

Let's see what the $2200 payment from the 40yr loan at 6% would buy us on a 30yr fixed loan at 6%: it would make a 30yr fixed mortgage payment on a $366,941 loan. By using the same payment on a 30 and 40 year loan, we would be able to purchase a house that is only $33,058 more expensive by using a 40yr loan. Would the lifestyle change really be that different between a $367,000 home and a $400,000 home?? The long term finances of it would surely be different. I guess it is up to the bwr to decide. I'm not here to tell you what to do, I'm just here to give you the math behind it. Goodness knows, very few brokers and real estate agents have YOUR best financial interests at hand.

Let's do something really crazy, and assume we actually want to pay our loans off, and live in a house with no mortgage. Look at the total payment amounts! At 6%, the 100 year mortgage saves about $393 a month, but you (and your heirs) would end up paying $1,542,696 MORE over the life of the loan than if you did a 30yr fixed. Even with the 40yr mortgage, you only save 198 bucks, but it costs you an extra $193,056 over the life of the loan.

BUT, let's assume that some of you are astute investors, and you take the money saved and you invest that money instead of buying cars, clothers, vacations, etc. Let's assume you take the $198 and invest it at 6%. At the 30yr mark, where your house would be paid off if you had done the 30yr loan, you would have $198,893 dollars saved (assuming no taxes/expenses/etc.), BUT you would still owe about $198,200. So, if you saved the money, got a 6% return for 30 years, you would just about break even.

Somehow, I think the odds of most people diligently saving and investing the difference is slim. Sure, some of you are going to say I could get 8 to 12% return on my money. Maybe you could, maybe you couldn't. There would be taxes, fund expenses, etc. I'm not here to debate the investment side of things, I'm here to show how the different loan periods can have a dramatic effect on the amount of money you will spend.

Hey wait a second, SoCal, most people only keep their house 5 years before bumping up or refinancing. Those statistics are true about people moving and/or refinancing. BUT people assume that because in the past property has gone up, that it will continue to do so. People generally move up when they have appreciation and/or they make more money. As we have shown, with rates rising, they will HAVE to make more money to afford the same size loan as before. With so many people doing "buy-now, pay-later" loans (ARM's, option ARMs, I/O, etc) they are not going to be able to afford to move up. They will barely be able to afford their own adjusting loans, nevermind taking on a larger loan at higher rates.

And now the larger loan sizes. I'm not going to write as much about these loans below. Just look at the numbers and see how higher rates, and longer mortgage periods really affect the payments.

$800,000 loan at 5% 30yr fix = $4294.57 . . . . .total pmt = $1,546,045
$800,000 loan at 5% 40yr fix = $3857.57 . . . . .total pmt = $1,851,633
$800,000 loan at 5% 100yr fix = $3356.18 . . . . .total pmt = $4,027,419

$800,000 loan at 6% 30yr fix = $4796.40 . . . . .total pmt = $1,726,704
$800,000 loan at 6% 40yr fix = $4401.71 . . . . .total pmt = $2,112,820
$800,000 loan at 6% 100yr fix = $4010.09 . . . . .total pmt = $4,812,108

$800,000 loan at 7% 30yr fix = $5322.42 . . . . .total pmt = $1,916,071
$800,000 loan at 7% 40yr fix = $4971.45 . . . . .total pmt= $2,386,296
$800,000 loan at 7% 100yr fix = $4671.01 . . . . .total pmt = $5,605,216

I know it is hard to read these numbers in the space provided, but I think it gives somewhat of a clear picture the "benefits" and drawbacks of the 40 and 100yr mortgages.

The benefit to the 40yr mortgage is that it will lower your monthly payment today, but you will spend hundreds of thousands of dollars more in the long run. If the only way you can afford a property is a 40yr mortgage or more, you probably need to wait, make more money, or look for a less expensive property.

I didn't even take into account that there is usually a 10, 25, or 35 basis point add for the 40yr program depending on the lender. I am using numbers that give these programs the benefit of the doubt, and I still don't think there are compelling savings or reasons to use these mortgages. Maybe it is just me, but I don't like the feeling of being in debt for 40 years. What do you think?

I'm sure there will be questions and things I will have to explain in further detail, so leave comments and I will do my best to answer your questions.

Thanks.

SoCalMtgGuy

31 Comments:

Anonymous Anonymous said...

Instead of getting a $400,000 loan at whatever rate for however long, why not move to Texas and buy a nicer home for $150,000? I've been amazed at the crap that $400,000 buys elsewhere that you couldn't sell for any money here in Texas. i don't see moving from here any time soon.

12/15/2005 5:29 AM  
Blogger Out at the peak said...

When do you think lenders will start issuing 100 yr loans on a large scale? Is it definitely the next program to come to light after 40 yr?

12/15/2005 7:12 AM  
Anonymous Professor said...

I've always viewed monthly interest payments as the cost of renting money. True it is paid in arrears (rents are typically paid in advance). True with real estate loans all or a portion is tax deductible (so I guess it would be better characterized as subsidized rent).

The problem some of these poor borrowers are going to be facing is that their monthly rental payments for borrowed money are headed for the roof. That is to say what they will be paying will have far less value than what they are receiving.

Put yourself in the shoes of a borrower who has financed $500,000 at an existing ARM rate of 5%. The act of that rate advancing to 7% effectively means their monthly rental fee for borrowed money will increase by $833.
$500K * 0.02 /12).

Now if you don't think this upward change is possible then all you need to do is look back 25 years in history to see a far worse scenario in terms of interest rates.

12/15/2005 7:45 AM  
Blogger Linq said...

OT I have heard of rumors of a mortage bailout from the gov from a guy who's roommate is in the mtg biz. It is supposed to help the dips who are in trouble w/their toxic loans. Do you know anything about this?

Also, I wanted to give you a pat on the back. I love reading your comments on Ben's blog. You are a great source of info and you help me 'keep the faith' when frustrations run high. Thanks!

12/15/2005 8:04 AM  
Blogger r patrick said...

SoCal-

The thing I noticed is the rate rising from 5 to 7 caused the payments for that house to go up a grand. I don't know baout you but having one less grand a month well leaves me with no money :)

As far as bailout on NPR they were talking to one of the Senators from LA with a request for a bill that will let homeowners sell their houses for 80% to the govt so they can lump them and sell the bigger plots to developers.

Mortgage compaies can sell off their loans for 40%...shades of things to come maybe?

Ling- I really hope that is not the case, I would hate to see the people who went in massively over their heads, got to have all the fun and the toys get bailed out for having the uberloans.

I feel a little less angry for FHB's that did not know any better but how can the agency that gets stuck with this tell that it's Jack and Jill trying to buy a place to raise their children versus the 100% cash out refi so that they can continue to live the "good life" and then get a bailout for it.

It also rewards the imprudent which is a dangerous precident to start.

12/15/2005 8:30 AM  
Blogger SoCalMtgGuy said...

r patrick,

I agree with you.

It is about leverage. the past few years we have let EVERYBODY with a pulse, leverage their property 100% or more. Many borrowers have no skin in the game, and will just walk away if/when they don't get appreciation.

My company and others will give 95% and 100% loans ONE DAY OUT OF BANKRUPCY!!!

Tell me how bright that is?!?!?

SoCalMtgGuy

12/15/2005 10:00 AM  
Blogger Former LA Homeowner said...

A 40-year loan is equivalent to debtor's prison. Just a nice vehicle for lending companies to take more of the borrower's money. I might as well rent and invest the difference rather than buy with a 40-year mortgage, especially in this overly hyperinflated real estate market (So Cal)

12/15/2005 10:47 AM  
Anonymous Anonymous said...

I think one of the issues that has not been discussed very much here is: Let's say you take the 40 yr. and save a couple hundred a month on your payments. Where are you going to find an investment with a rate of return higher than your mortgage interest rate?

People talk about getting 6% on your money as if it were guaranteed, or that stocks are going to return 10% because that's what they've done on average since 1926 or 1955, or 1982, or some other year.

Where is that written in stone?

Take a look at the rates of return on mutual funds over, say, the last five years. Since March of 2000, the average mutal fund is up nowhere near 10% per year.

Plus, with stock prices already inflated as measured by the S&P's PE and the retiring baby boomers likely to be cashing in all their assets over the next 20 years, there is no way stocks are going to return 10% per year over the next 40 years. I've seen estimates that the average will be more like 5 or 6%, and that's before inflation and taxes.

So, let's be optimistic and say you can get 7% over the next 40 years in stocks, or real estate, or whatever, and your 40 year fixed is at 6%. Let's say you really make the income you listed on your loan application to get that 500K 40 yr jumbo, which puts you in the 28/10 federal and state combined income tax bracket. Lets's also be super optimistic and say taxes don't go up and inflation only averages 3 percent over the next 40 years (yeah, right, with "Helicopter Ben" at the helm, don 't hold your breath).

.07 [nominal return] - (.07*.38) [taxes] - .03 [inflation] = .0134 [annual real rate of return on stocks (or whatever) after inflation and taxes]

.06 [nominal interest rate] - (.06*.38) [taxes] - .03 [inflation] = .0072 [real interest rate on your mortgage, after inflation and taxes]

.0134 - .0072 = .0062 [real net annual return after taxes on money essentially borrowed against house and invested in the stock market (or whatever risky asset class you choose)]

And that assumes no stock market crash or other economic disaster for the next 40 years, whereas the return on paying down your mortgage is guaranteed.

12/15/2005 12:46 PM  
Blogger SoCalMtgGuy said...

anon,

thanks for your analysis. I agree with you. I don't think the monthly savings is worth the risk.

If people were more rational with their thought making process, and were patient, I don't think there would be a need for 40yr mortgages.

Sort of reminds me of lowering the standards in school. Lowering the standards might be OK as it makes people feel better, but eventually there will be repercussions when knowledge (or mortgage payments) have to be delivered.

Thanks for the post!

SoCalMtgGuy

12/15/2005 1:05 PM  
Anonymous Ferromancer said...

40 year loans! hahahah! That means I'll be 65 by the time I "own" my home! The age that my future grandchildren with throw me into a nursing home! No thanks, I'd rather rent for the rest of my life.

12/15/2005 4:32 PM  
Blogger keith said...

is there no regulation - federal or state - of mortgages, mortgage terms and the mortgage business?

Even if there is not, it would seem the free market would take care of stuff like 40-years, no-docs, negative-am and no-down.

Not getting paid back should put an end to such stupidity by the financial community

http://housingpanic.blogspot.com

12/15/2005 10:55 PM  
Blogger SoCalMtgGuy said...

That is exactly what it will take. The problem is that there is a delay between making a mortgage and seeing problems.

Most of these products are untested in the long term. The lenders look at past default stats, but the loans they made in the past 12 months or so PROBABLY aren't showing up on their radar.

By the time the stats start showing much higher defaults, they will have already made 3-5 years worth of these loans.

It is a lot like the ole "driving a car through the rear view mirror analogy".

I'd rather investors lose money than the taxpayers spent 1 penny bailing anything or anybody out.

SoCalMtgGuy

12/15/2005 11:11 PM  
Anonymous Anonymous said...

Anonymous at 5.29am:

TX isn't a very good deal either. Your property taxes are out of control compared to other states.

12/16/2005 8:48 AM  
Anonymous Anonymous said...

This month's Dataquick review of housing prices &c (for Silicon Valley) just came out.

"As mortgage rates creep upward, more buyers are taking advantage of creative financing. The 40-year mortgage ``has become the loan of choice'' in the past six months, said John Marcell, president of the [California Association of Mortgage Brokers]..."

Whatever it takes to keep the music playing, huh.

http://www.mercurynews.com/mld/mercurynews/business/13421082.htm

12/16/2005 11:05 AM  
Blogger SoCalMtgGuy said...

Thanks for the link ANON!

SoCalMtgGuy

12/16/2005 11:17 AM  
Anonymous Anonymous said...

To follow up on the post regarding alternative investment returns, check out this commentary by a mutual fund manager:

http://www.hussmanfunds.com/wmc/wmc051212.htm

12/16/2005 5:39 PM  
Blogger tollhousecookies said...

Fannie Mae is seeking support for a 50 yr mort. look for it fall '06,
right before the caca hits the fan.
i'm serious.

12/16/2005 10:44 PM  
Blogger Price Doubt said...

None of the analyses here take into account the probability that in 20 years or so, both the payment and the balance owed will probably amount to a pittance. A house bought today for $400,000 might have a pricetag of $20 million by then.

If only I could get a $400K 200 year 6% fixed rate loan! :)

12/25/2005 11:27 AM  
Anonymous Anonymous said...

Not sure if people/potential buyer are still reading this blog as it is a few weeks old. Believe me, if your hopes to have 2 kids in a couple of years in this 800 sq. foot home, you'll regret it. Secondly, you won't be able to afford 2 kids on your salary with your mortgage payment. My husband and I make the same salary as you with one child and live in Phoenix (definite bubble here), much cheaper area and are o.k. financially, but I could not picture how we'd be if we had a large mortgage like you'll have, even with just one kid. We live within our means, have zero debt and pay cash for everything. Have you thought about how much day care will cost, and what are the day care options in your area? If you are a hipster you may find yourself very uncomfortable with your children in a typcial suburban day care and schools, etc. wow gold opportunity! I'd say you deal with the realities of having kids first, without the added headache of a larger mortgage in a smaller house.

7/17/2006 8:19 PM  
Anonymous Anonymous said...

Texas might have high property taxes but that's just to off set the fact that the state does not tax personal income. Do your research before you make dumb a$$ posts.

8/01/2006 4:38 PM  
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12/14/2006 10:22 PM  
Anonymous Mortgage said...

nice info

12/30/2006 11:06 PM  
Anonymous Anonymous said...

You saw it coming. Wow. Too bad no one took your advice.

2/06/2009 2:07 PM  
Anonymous QUALITY STOCKS UNDER 4 DOLLARS said...

a forty year mortgage sounds good.

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