High home prices pushes more buyers to 40-yr loans

Reuters ^ | Mon Aug 22, 2005 | Julie Haviv

[nickcarraway]

NEW YORK, Aug 22 (Reuters) - Sky-high prices are not preventing cash-strapped consumers from getting the house of their dreams now that lenders are letting them drag out the term of their mortgages to 40 years.

By moving from a fixed-rate 30-year to a 40-year loan, borrowers can stretch out loan payments and qualify for larger mortgages with lower payments.

While that seems to be good news for consumers, financial experts say the benefits are far outweighed by higher interest rates, 10 years of extra mortgage payments and a reduction in home equity.

"This (40-year) loan product screams of a budget-constrained consumer desperate to get into a home," said Gary Schatsky, a fee-only financial adviser/attorney. "This trend is disturbing to me, especially since it feeds into the growing obsession by consumers to get credit.

"They need to think through this mortgage's implications because in many cases, it will become their children's mortgage," said Schatsky, who is based in New York.

Incessant home price appreciation over the past few years has left some consumers with little choice but to seek riskier type loans, such as 40-year loans and interest-only loans.

The 40-year mortgage is more attractive than interest-only loans because borrowers build equity in their homes, albeit at a sluggish pace, and they are not vulnerable to rising interest rates, said Celia Chen, director of housing economics at Economy.com, a consulting firm.

The 40-year fixed-rate mortgage was created in the late 1980s by several California savings and loan associations.

With house prices soaring, there has been an uptick in demand over the past year for the loans, according to several lenders.

Lenders' interest in offering 40-year loans may grow, since as of June, they can sell certain 40-year fixed-rate loans to Fannie Mae , the nation's largest mortgage finance company.

Thirty- and 15-year fixed-rate mortgages comprise about 70 percent of the market, with adjustable rate mortgages accounting for nearly all the rest, according to the Mortgage Bankers Association, an industry trade group. The MBA does not track 40-year loan applications.

PROS AND CONS

Real estate brokers and lenders say consumers are being resourceful in taking out 40-year loans when double-digit home price appreciation has become the norm.

"Most borrowers do not plan to live in the house for 30 years, so a longer term is of no consequence," said Diane Saatchi, senior vice president with the The Corcoran Group, a major residential real estate firm.

"They figure to sell in about seven years; having 23 or 33 years left on the term is inconsequential," she said.

But 40-year loans have their critics, like Schatsky, who does not recommend them to to his clients unless they are severely cash-strapped or have a clear sense of future income streams.

Another research group, Bankrate.com, notes that interest rates on 40-year mortgages are generally 0.25 to 0.50 percentage point higher than on traditional fixed 30-year loans. That difference negates some of the benefits of the lower monthly payment.

Even with the same rate as on a 30-year loan, the 40-year loan's savings appear negligible.

For example, a $200,000 mortgage financed for 30 years at a fixed rate of 5.75 percent would carry a monthly payment of $1,167.15, Bankrate.com said.

By stretching the loan term an additional 10 years, borrowers, even at an identical interest rate, reduce their monthly payment by just over $100, to $1,065.78. However, the borrower also would have $16,389 less in equity at the end of the first decade of payments and would have paid an extra $4,200 in interest.

"This all stems from affordability and borrowers stretching themselves beyond their reach to get into a home they can't afford," said Economy.com's Chen. "What's next, a 50-year loan?"

Recent anecdotal evidence indicates that home price increases are beginning to decelerate, a sign the housing sector is starting to cool.

"When housing cools, so will these loans," said Schatsky. "If a consumer has to take out this loan to qualify for a home, their goal of homeownership needs to be seriously reevaluated."

[Fitzcarraldo]

And not long ago they were pushing 15-year loans.

[stylin19a]

and not long ago, ARMS were the worst way to go since the street loan.

[MikefromOhio]

However, the borrower also would have $16,389 less in equity at the end of the first decade of payments and would have paid an extra $4,200 in interest.

And if you have to move, you will be losing money from the get go....

[American Quilter]

Yikes. I can't imagine a 40-year loan. It'd be like a jail sentence. "You are condemned to pay off this mortgage for the rest of your life..."

[Alberta's Child]

My advice is that if you have to take out a 40-year loan to buy a house, then you can't afford the house.

[putupjob]

Let's see... interest only loans...

Doesn't that mean it will never be paid off?

[glorgau]

As my Uncle always told me when I was young,

"you want to own the house, you don't want the house to own you".

[Dog]

Good point.

[Gondring]

But with the tax code set up to reward those who can afford a home, what is someone to do who can't afford to buy otherwise? In many areas, any moderate-cost housing is bulldozed to build high-end properties.

[L98Fiero]

"My advice is that if you have to take out a 40-year loan to buy a house, then you can't afford the house."

Yep, it's like financing a car for 10 years. Buy something less expensive or put more down.

[Alberta's Child]

I've been saying for a long time that the mortgage interest deduction should be eliminated from the tax code. And anyone who has found himself in the Alternative Minimum Tax (AMT) bracket will tell you that the tax code could actually punish someone who owns his home.

[Huck]

That's cuckoo. We have a 20 yr mortage, but that's just for breathing room. We're on pace to pay it off in 15, but we wanted a little slack built in for hard times.

[Alberta's Child]

That's right. An asset or consumer product should never be financed for a period of time that exceeds its projected life span. It's a bit of a challenge to precisely compute the "life expectancy" of a home, but when you factor in all of the things that have to be repaired or replaced periodically I'm guessing it's something less than 40 years.

[Uncle Joe Cannon]

Coming soon to a housing market near you:

Banks offering long term (10+ year) leasing of homes.

[Uncle Joe Cannon]

Most people never pay off their home loan anyway, so the extra 10 years simply reduces equity when they sell/re-fi in 5 years.

[Alberta's Child]

That's an intriguing thought, but I expect these leases will include so many loopholes and protective clauses on behalf of the bank that it won't be worthwhile for people to take advantage of them.

Property taxes, for example, would be a major issue for both the bank and the tenant. A long-term lease like this would only be attractive for me as a tenant if the bank had to absorb any tax increases over the term of the lease. If the terms of the lease stipulated that the tenant has to pay for these increases, then I see no benefit to signing a deal like this.

[sittnick]

Question: My wife's family in Canada seems utterly unfamiliar with long-term fixed rate mortgages, everything seems to be done in terms of five year renewables mortgages. Do you know why that is?

[bpjam]

Financing is a tool. A 40 years loan COULD be a useful tool especially since virtually all houses built will last more than 40 years (as evidence by the 40 years old ones we have now). But it IS a tool and you need to understand it.

We see so many buyers now looking only at the payment and not caring about what kind of loan product they are buying. That is dangerous and usually stupid. Buyers are no longer locked into the same house for a generation (thanks to Newt and the Republican Revolution in 1995) so they are only thinking a few years at a time.

My thumbnail rule is that if you are aren't liquid enough to be able to sell your house and move in 90 days you probably shouldnt be screwing around with interest only loans and/or highly adjustable mortgages. But conversely, if you are planning on actually paying your mortgage for 30 years and owning your house free and clear, you are probably as ill informed as the worst guy on the other end of the spectrum. If you are really going to live in a house for 30 years, you will pay three times its value to the bank on that 30 year loan. Get a better loan product or put more money towards the mortgage as your income rises. You pay down more of your principal in the last 5 years than you did in the first 15 years on a 30 year fixed mortgage.

Mortgages are a banks best friend. But they can also be a great tool for consumers if you understand them and use them to improve your position continually. But ideas like banning the deduction of mortgage interest would basically crater the housing market and cost trillions in GDP. It would also wipe out a significant portion of the stock market as well as prevent families from building their single largest asset which is their house. You might want to tighten up some deductions on second homes and investment properties if you want to keep the lid on housing. But that would just essentially be more government regulation which caused our contraction in 1990 and 2000. Unless you are moving to an entirely flat tax or a VAT, the home mortgage deduction is one of the better social engineering tools. And the AMT should just be banned period. It actually hurts people who hold stock more than people who hold real estate since they are far more deductions in real estate.

[markman46]

depends on when it was built, I have several relatives that are still living in their original homes, and all have liven in the for close to 50yrs.