Have you ever talked to a man about his 1st car? Somewhere in the conversation you might hear, "Just think what she would be worth if I still had her, as the thought gleams from his eyes." For most, when it comes time to sell a car or home, we want to extract the maximum market value from our investment. I contend that there is a false impression on investment and return in the housing market, and it all boils down to the cost of doing business.
I recently read how Canada has accepted longer term mortgages and in California the 50-year mortgage is now available. I think this is great for the Real Estate industry, but catastrophic for the consumer. When I was a kid, most people that purchased a house with a mortgage did so with 10, 15 or 20 year mortgages. Today it is common for most to purchase a new home on a 30 year mortgage.
Some savvy Real Estate Agents mention to their clients that they can get more house and a lower payment with a 40 or 50 year mortgage. Wide-eyed buyers salivate at the thought of that upscale dream home and seriously consider these types of long-term mortgages. The advantage for the Real Estate industry is the result of selling higher price homes at a premium since a new market has opened up to those who could not have previously afforded higher priced homes on their modest salary.
Considering a simple example:
Example 1 Example 2
Purchase Price = $ 250,000 $ 250,000
Loan Amount = $ 200,000 $200,000
Interest Rate = 6.75 % 7.125 %
Period = 30 year 50 year
Monthly Payment = $ 1,297.20 $ 1222.55
Cumulative Interest = $ 266,990.63 $ 533,528.98
*Total Cost = $ 516,990.63 $ 783,528.98
* Includes 20% down payment, but not closing costs, taxes and insurance.
How many homes would an Agent sell after explaining to their client that the $250,000 home actually will end up costing them in upwards of $783,529. Probably not as many.
Now the interesting part:
The average price of a house in 1957: $ 2,330
The average price of a house in 2007: $ 212,800
(Source: http://www.nobosh.com/)
The values reflect an average price of a home, from 1957 to 2007, increased 91%; don’t get so excited yet. After correcting for inflation a more accurate comparison reflects a home value increase of 3.3%. The inflation corrected chart looks something like this:
and shows that in today’s dollars, a home in 1957 costing $100,000 would provide a comparable home today for $330,000. Using these adjusted values, we quickly determine that adjust home values actually have increased 3.3 times over a 50 year period. Referring back to our above example, a $250,000 home purchase in 2007 will have an equivalent value of $825,000 in 2057, resulting in a capital gain of $575,000.
Now for the punch-line:
If we kept our home for 50 years, made our payments according to the amortization plan, the difference between what we paid and what the value would be is:
1) 30 year mortgage: 2057 Home Value – Purchase Price – Interest = $308,009 Gain
( $825,000 - $250,000 - $266,991 )
2) 50 year mortgage: 2057 Home Value – Purchase Price – Interest = $41,471 Gain
( $825,000 - $250,000 - $533,529 )
The actual realized gains are $266,538 more by utilizing a 30 year mortgage.
With a disciplined investor the difference between the 2-mortgage payments could be invested during the 50 year period. Further considering the time value of money and compounding interest on returns, the resulting return on investment may offset or exceed the lower gain on the 50 year mortgage. Remember why the average consumer is considering a 50-year mortgage, they want more house and cannot afford the higher monthly payment. Hence, the difference between the 30- and 50-year monthly payments would not be available for investment.
The bottom line is this, by recommending a 50 year mortgage: 1) Agents can increase their commission by placing a client in a larger home than they otherwise would qualify, 2) Since other closing costs, points, origination fees, … etc. are based on a percentage of the loan value, the Title Company and Mortgage company will realize more return for their services due to the higher loan amount, 3) the Borrower will realize increased value from higher interest rates and potentially longer terms. Who pays for these types of loans, the Consumer.
What type of Loan Officer or Agent are you? One that wants what is best for your client, or best for your pocket book? This is the situation when business and morals justify the outcome.
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