Why 50-Year Mortgages Are Detrimental

      I’m going to be straightforward with my controversial opinion:

      If you require a 50-year mortgage, you can’t afford the home.

      Before you get defensive, let’s take a closer look at the concept of a 50-year mortgage, which has recently gained attention. We’ll analyze the numbers together.

      “Seriously, a 50-year mortgage? Is that real?”

      Unfortunately, it seems like it could soon become a reality.

      In 2014, the Federal Housing Finance Agency (FHFA) prohibited Fannie Mae and Freddie Mac from acquiring loans with terms longer than 30 years.

      Now, FHFA director Bill Pulte is trying to reverse this decision and has introduced the idea of a 50-year mortgage as a response to the housing affordability crisis.

      “But homes are costly, right? Won’t this help individuals buy homes?”

      Sadly, it’s quite likely that this could worsen the affordability crisis by driving home prices even higher.

      To clarify, let’s break this down into two parts – first, we’ll discuss why homes are unaffordable, and then we’ll evaluate the proposed solution.

      Part 1: “But homes are unaffordable, right?”

      Yes, home prices have surged, increasing by 56 percent since January 2020.

      This is fantastic for those who bought a home prior to the pandemic but terrible for anyone trying to enter the market as a first-time buyer.

      Home prices have skyrocketed for four primary reasons:

      First, there’s a lack of supply, which has been decreasing since before the Great Recession, impacted by various factors like municipal regulations concerning density and zoning.

      Secondly, extensive federal spending during the pandemic resulted in significant inflation, which is the worst shock we’ve faced since the 1970s. When inflation rises, prices for tangible goods, including homes, tend to increase. (This is why real estate is often viewed as a solid investment during inflationary periods.)

      Third, the fundamental cost of many materials, such as lumber and copper, has increased significantly.

      Fourth, the Federal Reserve slashed interest rates to near-zero to stimulate the economy, allowing many homebuyers to secure mortgages at 2% to 3%. This sparked a buying frenzy. If you attempted to buy a house in 2020, you likely recall the fierce competition, as homes would often sell quickly after being listed.

      To temper the economy, the Fed then raised interest rates, leading us to the present day. The average fixed rate for a 30-year mortgage is around 6.25%, based on Bankrate.

      This results in a significant difference between current interest rates and those buyers secured in 2020 and 2021.

      This considerable gap creates a lock-in effect, where current homeowners are reluctant to sell, which further limits supply.

      Counterintuitively, it also means that existing homes are on the market longer, as homeowners aren’t moving, and first-time buyers are being priced out.

      Thus, we have both a long-term supply issue and a short-term unfavorable environment for sellers.

      This combination of rising home prices and higher interest rates has caused the average monthly payment on homes to increase by 80% in the past five years, as reported by the Wall Street Journal.

      Consequently, fewer first-time homebuyers and younger individuals can afford to purchase a home. This year, the average age of a first-time homebuyer reached 40 for the first time.

      Now, let’s discuss the 50-year mortgage proposal.

      Part 2: “Won’t this help people buy homes?”

      Not really. These mortgages would feature two aspects: (1) lower monthly payments, and (2) higher interest rates.

      If you’re confused about why a 50-year mortgage would carry higher interest rates, the explanation is straightforward.

      Picture yourself as a bank deciding to lend several hundred thousand dollars for 50 years. You can’t predict how inflation will change during that period, nor can you foresee other opportunities you might miss out on. There’s also a longer duration for borrowers to potentially default.

      Thus, as a lender, if you’re committing your funds for a longer time frame, you’ll require a higher interest rate to compensate for the extended risk and reduced liquidity.

      That’s why 30-year mortgages typically have higher interest rates than 15-year mortgages.

      So, in response to the proposed question: “Won’t this help people buy homes?”

      Not as much as you would assume, given that the interest rates will also be elevated.

      Historically, the average spread between a 30-year mortgage and a 15-year mortgage is 0.55 percentage points, according to Bankrate.

      Let’s be generous to the idea of the 50-year mortgage and drop that to a hypothetical half-point difference.

      Let’s consider an example.

      You buy a home for $400,000 with a 20% down payment ($80,000); you pay closing costs in cash. Your loan amount is $320,000.

      With a 6.25

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