Monday, June 05, 2006

Ready To Write 600 Mortgage Payment Checks?

A new product is available from many lenders – a 50-year mortgage. Is it right for you? Probably not.

The primary attraction of the 50-year mortgage is that it allows for lower monthly payments. But these lower monthly payments come at a great cost, which for most homeowners would significantly outweigh the benefit.

Three characteristics of the 50-year mortgage that should give any borrower pause before entering into the loan are: (1) slow growth of equity; (2) the substantial amount of extra interest over the life of the loan; and (3) the risk of adjustable rates.

If you take a 50-year mortgage, then be prepared to build equity at a painfully slow rate. Consider a $200,000 50-year, 7.5% mortgage. After the first ten years of payments, you would have paid almost $150,000 in interest payments, and you would have accumulated less than $5,000 in equity. In contrast, consider if you had taken a $200,000 loan at 7.5% interest for 30 years, after the first ten years of the loan you would have paid almost $7,000 less in interest and you would have built over $26,000 in equity.

Clearly the equity builds at a much faster rate under the 30-year loan. This is an important advantage, as one of the main benefits of home ownership is to build equity over time. Also keep in mind that you would be paying an enormous amount of extra interest over the life of a 50-year mortgage. Using the example above, you would pay $264,845.87 extra in interest over the life of the loan!

Of course, the monthly payments on the 30-year mortgage would be $118 higher than the 50-year mortgage. But when taking into account the faster equity growth and the enormous saving in interest expense, it is plainly worth the slightly higher monthly payment.

Also keep in mind that most 50-year mortgages currently offered by lenders provide a fixed rate for the first 5 years, after which the rate becomes adjustable. That means that after 5 years your monthly payment could increase.

With all the potential hazards, who should consider a 50-year mortgage? An ideal borrower would be someone who plans to stay in a home for less than 5 years, and does not want to take an "Interest Only" or "Option ARM" loan. With a 50-year mortgage you do not run the risk of owing more than you borrowed, which is a real possibility with some Interest Only or Option ARM loans that allow a borrower to pay even less than the interest due each month.

While this new product may be a good alternative for a small percentage of homeowners or investors, for most people, entering into a half-century mortgage IS NOT PRACTICAL.