Why Is the 30-Year Mortgage Sacrosanct?
September 21, 2007
Maybe I’m being naive. Or maybe there’s a lending rule I’m unaware of. But it seems to me that a lot of homeowners facing foreclosure would be well served if their lenders worked with them to refinance their debt over 40 years instead of 30. Why is the 30 year mortgage the gold standard?
Shailesh, I’m counting on your comments!
I suspect that the 30 year mortgage is based on olden days, back in the 1930’s and 1940’s (or 20’s?) when home mortgages became common. Back in the day, folks lived in the same house for 30 years or more. Dad worked at the same company for 30 years until he retired. He probaby started work at age 18 or 22 and retired with the house all paid off when he was in hid mid-50’s. People didn’t live much longer than their late 50’s, early 60’s, so this system probaby seemed logical to everyone involved.
But times have changed. Almost nobody pays off a house through actual payments anymore. Americans are living to 80 and 90. Most live in a house only 3 to 7 years before they refinance or sell (and pay off their lender). And if the lenders are willing to lend huge sums of money on a 30 year mortgage, knowing full well that most borrowers will pay off the mortgage through a refinance or sale, then why not lend the same huge sum of money on a 40 year loan? What’s the difference?
Take your average $200,000 loan at 6.25% for 30 years. Payment is about $1231 a month. Stretch that out to 40 years and the payment drops over a hundred bucks to $1135.
Let’s imagine a real scenario (one based on a client of mine). Homeowner owes $200,000 at 8.125% and another $50,000 at 10.25%. Together, these are a $1933 per month payment. If the lenders both agree to extend to 40 years, and shave a little off their rates, the homeowner could see a drop of nearly $200/month in the payment ($200,000 @ 7.75% over 40 years + $50,000 @ 9.00% over 40 years). Two hundred a month is significant to this homeowner. It means the difference between holding onto her house, or facing a short sale.
Lenders would make more money in interest payments over 40 years than over 30. The buyer-borrowers could afford to stay in their homes. Lenders avoid the loss they almost always take when they foreclose on a home.
So why is 30 the sacrosanct number in mortgages?
September 23, 2007 at 2:49 am
Heather,
This is a great question and you pose a great set of answers. The root of the amortizing loan goes back to the Roosevelt Administration. This is because the during the great depression loans were mostly interest only with a 10-year balloon payment. However, from my understanding loans after the war were usually 15 year loans. The 30 year loan didn’t really become fashionable until about 20 or 30 years ago.
Now lenders do offer 40 year and even 50 year loans. In an amortizing loan after about 40 years the drop in payment is usually not high enough to compete against an interest only loan. This is because the longer time horizon means greater risk for the lender and so they charge a higher rate.
In essence the 30-Year mortgage is not sacrosanct. In face the points you raise are exactly what mortgage pros have been telling folks and putting them on ARM’s, Interest Only loans etc.
In today’s climate many lenders are working with borrowers to re-cast their loans. If you have been making good payments for several years and you need some help because of some hardship you can call the bank and ask them if they would be willing to re-amortize your loan over 40 years. Heather, the solution you are proposing is absolutely on the table.
Now the problem is that the folks facing hardship got into mortgages with a short fixed period (a 2 year ARM), or simply bought over their heads with these exotic low doc loans. It’s harder to help these folks that you might think. That is why the government has come up with the Secure FHA program.
Finally, another thing to keep in mind is that doing a loan modification on a loan that has been sold as a security instrument is difficult. While the servicer may be willing to do the modification, the folks holding the security have to also agree. Again, federal regulators have asked these guys to work with consumers. We’ll see what happens.
There is a lot more to this issue than what I have covered here. This is a great topic Heather. I may even blog about this so I can cover more issues. I’ll even try to see if I can’t call you out on some real estate issue.