50-Year Mortgages?
We’ve recently heard proposals about a 50-year mortgage term here in the US.
Unsurprisingly, most experts think this is a very bad idea as it will do nothing to lower home prices (and if anything, as I’ll try to prove below, it will likely raise prices).
That said, in a vacuum where I was looking to buy a home and I was given the option to get a 50-year mortgage for only a small increase in the interest rate, I would do it in a heartbeat.
I love the flexibility of a lower payment where I always can pay extra principal and amortize the mortgage much more quickly on my own terms.
I also know that it’s statistically unlikely that I’ll live in the house anywhere near 30-50 years, so I’m really just managing my monthly payments and I want to do whatever I can to lower that payment.
But in general, I think 50-year mortgages are bad for society because they will likely raise home prices and an even smaller fraction of your monthly payment will go to pay down principal.
So, this is another interesting societal item like Social Security:
I know I could do better investing my social security taxes on my own, and that I’d personally have a higher net worth, but I’m so glad the Social Security program exists for society.
I would personally do better with a 50-year mortgage (in a vacuum where home prices didn’t rise because of the availability of the 50-year option), but I know it’s bad for society.
Here’s an updated version of a newsletter section I wrote in April of 2022:
Impact of Length of Mortgage
One of the more unusual thoughts I hold about personal finance is this:
Our homes don’t have a specific inherent value.
What I mean by that is:
Since most people finance 80% to 99% of their home purchase price through a mortgage, the actual market value of the home isn’t the only, or even the major, determining factor in whether one can afford a new home.
What truly matters is the monthly payment.
Can you afford the payment? If so, most people don’t really care what the actual sticker price of the home is.
There are 3 major factors when calculating the Principal & Interest (P&I) portion of the mortgage payment (excluding property taxes and insurance):
- Length of term
- Interest rate
- Amount financed
Changing any one of these 3 will impact the monthly payment when you run it through a mortgage calculator.
Length of Term Examples:
Base case: A 30-year loan for the full purchase price of a $300,000 home at 4% interest leads to a P&I payment of $1,432 per month.
10-Year Loan Term:
Let’s change one variable and hypothetically say rules go into place where a 10-year mortgage was the longest possible term, so now we’re looking at a 10-year loan for $300,000 at 4% interest. The monthly payment jumps to an astonishing: $3,037.
Do you still think that home is “worth” $300,000?
No chance.
Or is it more like $142,000 that would produce a similar monthly payment to the original $1,432?
50-Year Loan Term:
Let’s now look at the 50-year mortgage in this scenario, so now there’s a 50-year loan for $300,000 at 4% interest. The monthly payment drops to: $1,157.
Do you think the market value is still only $300,000?
$371,500 is now the price that would produce a similar monthly payment to the original $1,432 with a 50-year term.
I strongly suspect that introducing 50-year mortgage terms will only enrich existing homeowners and lead to a nearly instant increase in home values across the United States.
That clearly isn’t the intention of that policy, but it would be the likely result.
Everything Compounds
I saw a quote on Facebook from someone named Scott D. Clary and I thought it was perfect for our community:
“What successful people understand:
Everything compounds.
- Reading compounds into knowledge
- Exercise compounds into health
- Kindness compounds into relationships
- Small actions compound into big results
Nothing happens, then everything happens. That’s the compound effect.”
This is the perfect mindset for those of us pursuing Financial Independence. We think long-term. We know that the inputs matter. When you keep plugging away month after month, year after year, you’re almost guaranteed success.
Success in life is measured in decades.