Posted on 08/23/2005 2:16:30 PM PDT by 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."
The big grin on my face comes from having a 15-year mortgage that's less than four years from being paid off.
You can dream up all kinds of worst case scenarios. Usually, neighborhoods don't deteriorate overnight. In any case, there are few instances where, in absolute terms, a property's value goes down over a 40 year period regardless of neighborhood. I seriously doubt that you could find a property with a 1965 mortgage, which hasn't appreciated. Inflation alone will make the mortgage payments go down vis-a-vis one's income.
I stated specifically that you should purchase a home that was affordable. Usually, the mortgage shouldn't be more than two to three times your income or comprise more than 28% of your expenses. The question is whether you want to own a paid up house, which has equity you are not using versus a mortgage that frees up money for other uses, including investment. The equity in your home is like putting it under your mattress. If it makes you feel better to have a paid up house, so be it.
My primary residence has increased in value more than six times what I paid for it in 1979. I have refinanced four times to take some equity out for investment, home improvements, college tuition, and consolidation of consumer debt. My present mortgage is still about 40% of the appraised value and it is at a fixed rate of 5.75% for 30 years, with the first ten being interest only. Historically, interest rates have averaged around 8% over the past 40 years. The bottom line is that your home equity can be a good source of funding for other purposes and it is tax deductible unlike other forms of debt. Like anything else, you need to exercise good judgement and prudence in how you use it.
as the years go by, the banks and speculators will own all US real estate. mortgages will be what average people pay, essentially as rent - nothing towards home ownership, with 40 year interest only loans becoming the norm.
How you evaluate risk affects whether you would rather have a paid for home or investments. To help you decide, answer this question for yourself, "If your house was paid for, would you take out a mortgage and put the money in the 'investment'?".
There is also a growing push for the interest only loans. Most buyers don't stay in their first or second home long enough to build any appreciable equity as their P&I payment is almost all interest. Any equity built up is due to market appreciation, so for many home buyers an interest only loan enables them to buy a better home for less monthly outlay. Not a bad deal if you're not planning on staying in the house and trust market forces to appreciate the value of the home.
STOP THE INSANITY!
I don't give a dang about flashy and new...I'm talking about free-market economics. In the current market, more profit can be made by demolishing lower-cost housing and replacing it with McMansions. Why should anyone sell low-cost housing then?
This creates longer commutes for lower-income housing, but with gas prices up, that's not tenable.
The market would adjust by raising wages to compensate, but for one thing...the influx of single immigrants willing to live in high-density. In other words, a family cannot compete.
That's the 21st Century in much of America.
...and it looks like I'm not the only one pointing this out. :-)
Yep, it's like financing a car for 10 years. Buy something less expensive or put more down.
yep. When I bought my 2004 Sonata last year (excellent car BTW) the credit uniion offered me "gap insurance" for $275. First I had heard of it. But it says volumes about the way people are spending borrowed money. Positively scary to have come to this.
If you don't know what it is, should your car be stolen or totaled, it's insurance that will pay the difference between what it's worth and what you owe. IOW, most the the cars being financed are upside down most of the life of the loan, because they depreciate 40% the first year.
"The Estimated Remaining Economic Life" of the house we just purchased according to the lender was over 80 years. This home is already 30 years old. So, 110 years according to the lender on this house. That would be it's life expectancy. We took out a 30 year mortgage, If I make just regular monthly payments, I will be 63 years old when finished. If I ever refinance (doubtful, because interest rates are at an historic low right now), I would do a shorter term than that because I don't want to be older than 65 when I am finished paying it off.
Probably. It depends on the investment vehicle, my goals, stage of life, etc. If I could be reasonably certain that the return on the investment would exceed the cost of the mortgage (which is tax deductible), I would not hesitate to do so.
I should clarify my original statement here. I'm not opposed to a 40-year mortgage just on priciple, but in a specific case where someone who can't afford a home on a 30-year mortgage but thinks they can on a 40-year mortgage.
If you take a 30-year mortgage for $250,000 with a fixed rate of 5.5% and a 40-year mortgage for the same $250,000 with the same fixed rate, the difference between the monthly payments is only about $130. More likely, the 40-year mortgage will have a slightly higher rate. With a 40-year rate of 5.75%, the difference on a monthly basis is less than $90.
If $90 or $130 per month really makes that much of a difference for a potential home buyer, then I really don't think they can afford the home.
Your last paragraph is particularly interesting, since some of the points you make really go to the heart of my opposition to the mortgage interest deduction. The fact that eliminating this deduction would cause a collapse in housing prices is exactly my point -- these home prices have been inflated by what is essentially a government subsidy. Elimination of this subsidy will result in higher interest costs for consumers, but this increase will be offset by the reduction in home prices. If the market dictates that I can afford to make a $2,000 monthly mortgage payment and get $300 of that back in the form of an income tax deduction, then eliminating the deduction will simply mean that I can afford a mortgage payment of $1,700 per month. The price of these homes will adjust accordingly.
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.
I think you may be wrong about this statement. I believe the AMT hurts people who hold real estate more than people who own stock precisely because there are far more deductions in real estate -- since many of these deductions are eliminated under the AMT.
While it is true that people can live in homes that are 50, 80, or even 100+ years old, it doesn't mean these homes have a "life span" that long. When you look at all of the various things that have to be replaced or rehabilitated over that period of time (replacing the roof, paving the driveway, replacing major electrical/plumbing components, etc.) you will often end up with a 50 year-old home that is comprised of elements that are 5, 10, 15, etc. years old.
I seem to remember that the IRS requires a 26.5-year depreciation schedule for tax purposes for investment properties. While this is not necessarily an accurate indicator of a building's life cycle, it probably has some kind of correlation.
I run into an increasing number of people who tell me that their monthly property tax payment is higher than their mortgage payment. Sh!t -- at that point you may as well sell the house and live in a cardboard box, since you really don't own it anyway.
See #54.
This is a very prudent approach to paying off a mortgage. Now try doing the same thing with other large expenses you incur over time. Like a vacation, for example . . . you can reward yourself and your family by taking a vacation that costs 3% of last year's income (or something like that).
While it may be true that your house will still be standing after 110 years, the "life expectancy" of that home is far less than that.
Think of an ordinary claw hammer as a case in point. Suppose you buy a new claw hammer today, and you have your mind set on keeping that thing for as long as you live. If you replace the handle after 10 years and then replace the head after 15, you've effectively replaced your original hammer even though you've never really replaced the entire thing at one time. If you replace the handle every ten years and the head every 15 years, then after 35 years you'll be on your fourth handle and third head -- without ever having purchased a new hammer.
A home is obviously far more complex, but it contains a number of components that must be replaced on a regular basis if you have any intention of keeping it for 110 years. The one component that has an "infinite" life span is the land itself.
Vacation? What's that?
Only kidding. Great approach, I'll give that a try. We tend to take a fair amount of vacations - three days here, three days there over the summer and a big on those parent teacher conference weeks. The ladies always like to visit the Mouse!
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.