I’m just going to come straight out of the gate with a hot take:
If you need a 50-year mortgage, you can’t afford the property.
Before you grab your pitchforks, let’s explore the new concept of a 50-year mortgage, which just entered the zeitgeist this week.
We’ll run the numbers and math this out.
“Seriously, a 50-year mortgage? Is that a thing?”
Unfortunately, it looks like it might become the newest thing.
In 2014, the Federal Housing Finance Agency (FHFA) stopped Fannie Mae and Freddie Mac from purchasing any loans with terms longer than 30 years.
Now, FHFA director Bill Pulte says he’s working to reverse this decision, and proposed a 50-year mortgage as a solution to the housing affordability crisis.
“But homes are unaffordable, right? Won’t this help people buy homes?”
Unfortunately, there’s a decent chance that this will only add to the affordability crisis — driving up home prices further.
To explain why, let’s take this question in two parts — first, let’s establish why homes are unaffordable, and then let’s look at the proposed solution.
Part 1: “But homes are unaffordable, right?”
Right. Home prices have skyrocketed, climbing 56 percent since January 2020.
This is great news for anyone who purchased a home before the pandemic, and of course, sucky news for anyone trying to become a first-time homebuyer.
Home prices have soared for four main reasons.
First, lack of supply, which has been dwindling since before the Great Recession. A huge variety of factors contribute to this, including municipal-level regulations such as density limitations and zoning requirements.
Second, massive pandemic-era federal spending led to the most severe inflation shock that we’ve had since the 70s. When inflation rises, the prices of tangible goods — including homes — tends to climb. (That’s why real estate is such an attractive investment during inflationary periods.)
Third, the underlying cost of many materials, including lumber and copper, have spiked.
Fourth, the Federal Reserve lowered interest rates to near-zero in order to stimulate the economy, which led to a many homebuyers scoring 2% to 3% mortgages.
This fueled a home buying frenzy. If you tried to buy a home in 2020, you probably remember the enormous competition, as homes would frequently fly off the market the moment they were listed.
In order to cool the economy, the Fed then had to raise interest rates, which brings us to today. The average fixed rate for a 30-year loan is around 6.25%, according to Bankrate.
This means there’s a wide delta between today’s interest rates vs. the interest rates that buyers locked up in 2020 and 2021.
That massive gap creates a lock-in effect, in which existing homeowners don’t want to sell, which further curtails the supply.
Counterintuitively, it also means that existing homes linger on the market for longer, because existing homeowners aren’t buying, and first-time home buyers are priced out.
So we simultaneously have a supply problem (in the long-term) and also an environment that’s bad for sellers (in the short-term).
This combination of higher home prices plus higher interest rates means that the average monthly payment on homes has gone up 80% in the last five years, according to a Wall Street Journal report.
As a result, fewer first-time homebuyers and young people can afford a home. This year, the average age of a first-time homebuyer reached 40 for the first time.
This leads us to the 50-year mortgage proposal.
Part 2: “Won’t this help people buy homes?”
Not much. These mortgages would have two features: (1) lower monthly payments, and (2) higher interest rates.
If you’re scratching your head, wondering why a 50-year mortgage would have higher interest rates, the reason is simple.
Imagine that you’re a bank, and you’re thinking of tying up a few hundred thousand dollars for 50 years.
You don’t know how the inflation rate is going to fluctuate during that 50-year period, nor do you know what other opportunities you might miss out on. There’s also a longer time period for the borrower to default.
So — as a lender — if you’re going to tie up your money for a longer period of time, you’ll demand a higher interest rate in order to compensate yourself for that extended risk and lack of liquidity.
That’s why 30-year mortgages have higher interest rates than 15-year mortgages.
So, to directly address the proposed solution: “Won’t this help people buy homes?”
Not as much as you would think, due to the fact that the interest rates will also be higher.
Historically, the average gap between a 30-year mortgage and a 15-year mortgage is 0.55 percentage points, according to Bankrate.
Heck, let’s be generous to the 50-year mortgage and round that down to a mere half-point difference in our upcoming hypothetical.
Let’s look at an example.
You purchase a $400,000 home with a 20% down payment ($80K); you cover closing costs in cash. Your loan amount is $320,000.
At a 6.25% interest rate over 30 years, the principal and interest portion of your mortgage comes to $1,970 per month. (This excludes insurance and property taxes, which vary by location).
At a 6.75% interest rate over 50 years, the principal and interest portion of your mortgage comes to $1,864 per month.
You save $106 per month.
And what do you “get” for those savings?
The 30-year mortgage will cost a total of $709,306 in principle and interest (across 360 payments). You’ll pay $389,306 in interest.
The 50-year mortgage will cost a total of $1,118,641 in principle and interest (across 600 payments). You’ll pay $798,641 in interest.
Dude.
I cannot emphasize enough what a bad idea this is at the individual level.
But what’s worse is that it’s likely only going to exacerbate the affordability problem.
“Okay. So I get that a 50-year mortgage is a bad idea at a personal level, because we’d pay a lot more in interest.
“But how will this make homes more expensive?”
Glad you asked.
Think back to late 2003, when Fannie Mae began buying 40-year mortgages through a pilot program.
In June 2005, Fannie Mae expanded its 40-year mortgage program.
We all know what happened in 2008.
Borrowers holding 40-year mortgages were in homes they could not afford. They had also built very little equity. (Remember, mortgages are amortized, so the bulk of initial payments is applied to interest — and the longer the loan term, the slower the equity growth.)
These borrowers were among those with the highest rate of default during the Great Recession.
Today’s borrowers are already stretched thinner than they were back then. Nearly 70 percent of new FHA borrowers have debt-to-income ratios above 43 percent, which used to be considered risky territory.
During the pandemic, Ginnie Mae introduced a pool of modified loans with terms up to 40 years. This was supposed to be a temporary solution to soaring home prices, allowing for lower mortgage payments during a crisis.
However, even today you still can get a 40-year mortgage, although these are more rare (stricter qualification standards).
In theory, this sounds like help. (Lower payments – yay!) In reality, it keeps people in homes they can’t afford, which tightens supply even further.
When fewer homes hit the market, prices stay high, and the next round of buyers has to stretch even more just to get in.
It’s a cycle that feeds on itself: more leverage, higher home prices, and even riskier loans to make those prices “affordable.”
So what can you do? Don’t play that game.
If the only way you can afford the home is by locking yourself into a 50-year mortgage, then you’re better off renting.
If you need a 50-year mortgage, you can’t afford the property.
Avoid these loans, and encourage your friends and family to steer clear, too.
Because the only way this cycle ends is if enough of us stop pretending that digging ourselves into excessive debt is a solution.
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