Trump proposes 50-Year Mortgage

[Calheel]

I know how amortization works. I'm wondering why it is the default to front load interest for mortgages vs something like a car loan where interest is equally distributed between monthly payments.

I would guess that this bank friendly policy ultimately leads to lower interest rates, but I really don't know.

I am not aware of any loan that works the way you describe. Lenders are not front-loading interest. Interest comprises a larger portion of the payment until the principal comes down. It is just math.

Perhaps you have seen repayment schedules showing a certain portion being interest and a certain portion being principal over the life of the loan. That is just an average. Because it is certainly not how math works.

 

[SnoopRob]

This thread reminds me of something I heard on POTUS Politics on SiriusXM the other day.

They were discussing the 50 year mortgage and how you'll be paying almost entirely interest for the first couple of decades of the loan. The host (don't remember who it was but an otherwise smart person) asked why are banks allowed to make you pay so much in interest early on and if congress has thought of doing something about it.

I was floored by the ignorance of the comment. The guest just kind of brushed the question off but I wish she would have said, "It works that way because of math. It isn't some kind of conspiracy against borrowers." It literally can't work any other way or it would be easy to game the system.

I know not everyone has competent at math just like I am not competent at doing what they do. But, my goodness.

I actually understand the reasoning behind the question. For folks who may not live somewhere more than a few years at a time (in their 20s and early 30s, especially), the fact that early loan payments are largely interest means that home ownership doesn't always make financial sense unless they know they'll be somewhere 5+ years. And so these folks, who might be interested in buying, rent instead because they don't want to lose money on buying a house and moving in 3 years.

So I get that for a lot of these folks (who are definitely a subset within the overall market), the idea that the interest could be prorated over the course of the entire loan period so that they are building greater equity much sooner after purchase is very appealing.

And, let's be honest, if you aren't a finance type who understands how the bank getting their money up front impacts their loan-making activities, then it does seem a bit "unfair" that the bank "gets their first" and so it would seem a natural fit that the government would create a law that meant banks had to prorate interest in the name of "fairness".

 

[gtyellowjacket]

I am not aware of any loan that works the way you describe. Lenders are not front-loading interest. Interest comprises a larger portion of the payment until the principal comes down. It is just math.

Perhaps you have seen repayment schedules showing a certain portion being interest and a certain portion being principal over the life of the loan. That is just an average. Because it is certainly not how math works.

Yeah. You're right. I thought it was exclusive to mortgages but its just about all asset loans. Never really thought about it before but I haven't had a car loan in a long time.

And that's no excuse. I have an MBA with a finance concentration from UNC. My professors would be appalled.

 

[aGDevil2k]

I thought my first house would be a good source of equity when I sold it. I wasn't planning to get much off of principal - just the value gain.
Sadly I bought it in 2002. I sold....in 2010. Lost $15K. Oh well still worked better than renting because then, at least I got interest deductions. Of course that same townhome has tripled in value since 2010.

 

[Calheel]

I actually understand the reasoning behind the question. For folks who may not live somewhere more than a few years at a time (in their 20s and early 30s, especially), the fact that early loan payments are largely interest means that home ownership doesn't always make financial sense unless they know they'll be somewhere 5+ years. And so these folks, who might be interested in buying, rent instead because they don't want to lose money on buying a house and moving in 3 years.

So I get that for a lot of these folks (who are definitely a subset within the overall market), the idea that the interest could be prorated over the course of the entire loan period so that they are building greater equity much sooner after purchase is very appealing.

And, let's be honest, if you aren't a finance type who understands how the bank getting their money up front impacts their loan-making activities, then it does seem a bit "unfair" that the bank "gets their first" and so it would seem a natural fit that the government would create a law that meant banks had to prorate interest in the name of "fairness".

The interest vs. principal issue is not why buying for short periods doesn't make financial sense. Because it is all essentially interest when you rent.

It is simply the transaction costs with selling a house, which is roughly 6-10%. You need to live in a property long enough to overcome the selling transaction costs. If you could sell for no costs, then it would almost assuredly pencil out better to buy a house over renting a house, even if you are in an interest only loan.

 

[Willy]

I am not aware of any loan that works the way you describe. Lenders are not front-loading interest. Interest comprises a larger portion of the payment until the principal comes down. It is just math.

Perhaps you have seen repayment schedules showing a certain portion being interest and a certain portion being principal over the life of the loan. That is just an average. Because it is certainly not how math works.

Yup. APR = annual percentage rate. Key word, annual. Multiply the interest rate by the balance and divide by 12, you have your interest carry for the month. As that princ balance decreases, interest carry decreases, meaning more goes to the loan balance. Works this way on any amortizing debt, including car loans and mortgages.

 

[gtyellowjacket]

I thought my first house would be a good source of equity when I sold it. I wasn't planning to get much off of principal - just the value gain.
Sadly I bought it in 2002. I sold....in 2010. Lost $15K. Oh well still worked better than renting because then, at least I got interest deductions. Of course that same townhome has tripled in value since 2010.

Similar but I bought in 2005. Ugh.

 

[Calheel]

Yeah. You're right. I thought it was exclusive to mortgages but its just about all asset loans. Never really thought about it before but I haven't had a car loan in a long time.

And that's no excuse. I have an MBA with a finance concentration from UNC. My professors would be appalled.

Wow. A mea culpa on this board from anyone is a rarity. @CFordUNC is the only one I know that regularly does that. You are a good role model.

 

[mpaer]

It is simply the transaction costs with selling a house, which is roughly 6-10%.

I bought a house 35-40 years ago I refinanced the whole thing to straightened out debt. I bought out half from the ex. a frew years later Yes I sold it a couple years later
State employees Credit Union really must love me

 

[heelinhell]

The fixed rate on a 50 year mortgage payment doesn't appear to be much better than a 30 year so I'm going to wait to see if I can get a better deal on a 100 year fixed rate mortgage.

I am 74 years old so I don't really care about the impact on paying down principal on the loan. Odds are the loan balance will be significantly higher when I kick the bucket which will be a problem for my kids but I will be dead so what me worry.

I own my house free and clear and just want to collect 90% of the appraised value to reinvest in bitcoin/crypto currency and lottery tickets.

 

[ChapelHillSooner]

The fixed rate on a 50 year mortgage payment doesn't appear to be much better than a 30 year so I'm going to wait to see if I can get a better deal on a 100 year fixed rate mortgage.

I am 74 years old so I don't really care about the impact on paying down principal on the loan. Odds are the loan balance will be significantly higher when I kick the bucket which will be a problem for my kids but I will be dead so what me worry.

I own my house free and clear and just want to collect 90% of the appraised value to reinvest in bitcoin/crypto currency and lottery tickets.

You should get one of those reverse mortgages just to f' over your kids more. ;-)

 

[SnoopRob]

The interest vs. principal issue is not why buying for short periods doesn't make financial sense. Because it is all essentially interest when you rent.

It is simply the transaction costs with selling a house, which is roughly 6-10%. You need to live in a property long enough to overcome the selling transaction costs. If you could sell for no costs, then it would almost assuredly pencil out better to buy a house over renting a house, even if you are in an interest only loan.

The interest vs principal issue is part of why buying for short periods doesn't make financial sense. If interest were prorated over the life of the loan, then one would build equity much faster which would be realized no matter how long (or short) the next sale occurs after purchase. As you note, transaction costs are a bigger issue, but how fast one builds equity is the antidote, so to speak, for overcoming the transaction costs. (There are also ways to lower transactions costs, but that's a different topic.)

Conventional wisdom has been that one needs to stay in a purchased home for roughly 5 years to break even. At the higher interest rates we're seeing today, conventional wisdom says that the break-even point is now closer to 10 years. That's quite a significant amount of time for someone to be "trapped" in a house before being able to break even upon selling the house. Based on that, I can see why some folks would push the idea that banks should get their money over a longer period of time in order to assist homebuyers in having more flexibility in selling without taking (as much of) a loss.

 

[Calheel]

The interest vs principal issue is part of why buying for short periods doesn't make financial sense. If interest were prorated over the life of the loan, then one would build equity much faster which would be realized no matter how long (or short) the next sale occurs after purchase. As you note, transaction costs are a bigger issue, but how fast one builds equity is the antidote, so to speak, for overcoming the transaction costs. (There are also ways to lower transactions costs, but that's a different topic.)

Conventional wisdom has been that one needs to stay in a purchased home for roughly 5 years to break even. At the higher interest rates we're seeing today, conventional wisdom says that the break-even point is now closer to 10 years. That's quite a significant amount of time for someone to be "trapped" in a house before being able to break even upon selling the house. Based on that, I can see why some folks would push the idea that banks should get their money over a longer period of time in order to assist homebuyers in having more flexibility in selling without taking (as much of) a loss.

That makes no sense to me. Would you agree that the bank could defer paying you interest on your savings?

If you are using someone else’s money, you need to pay the cost of that. Otherwise, they could just invest the money in the stock market. Apple isn’t telling the bank that it will only pay half a dividend.

 

[SnoopRob]

That makes no sense to me. Would you agree that the bank could defer paying you interest on your savings?

If you are using someone else’s money, you need to pay the cost of that. Otherwise, they could just invest the money in the stock market. Apple isn’t telling the bank that it will only pay half a dividend.

What makes no sense to you?

If I do a certificate of deposit, then I agree to get my interest at the end of the CD (i.e. "loan") period.

It's would be the same idea applied to house loans, although instead of deferring to the end of the loan period it would be prorated out through the loan period.

To be clear, no one is saying that banks would want to do this, more that it would come from government regulation/law. And I'm not saying it's a good idea, just that I can understand why some folks would want to enact such a regulation/law.

 

[ChapelHillSooner]

That makes no sense to me. Would you agree that the bank could defer paying you interest on your savings?

If you are using someone else’s money, you need to pay the cost of that. Otherwise, they could just invest the money in the stock market. Apple isn’t telling the bank that it will only pay half a dividend.

The only way to do that would be an adjustable rate mortgage where the interest rate was a lot lower at the beginning than at the end.

Of course such things exist but the interest rates generally skyrocket to make up for the initial low rate. There's always a catch and there has to be otherwise people would put their money elsewhere.

As for the rule of thumb about owning a house, that is mostly because of transactional costs on both ends.

 

[SnoopRob]

The only way to do that would be an adjustable rate mortgage where the interest rate was a lot lower at the beginning than at the end.

Not necessarily, you could simply determine what the total interest at X.XX% of the total repayment amount would be and prorate each monthly payment according to that percentage. For instance (using a mortgage calculator):

On a $400,000 loan at 5% APR on a 30-year fixed rate, the monthly payment would be $2,147.29 and the total interest paid over those 30 years would be $373,023.14. Since $373,023.14 of the total payments to be made of $773,023.14 (principal plus interest) is 48.255%, then you'd simply say that each month 48.255% of each payment ($1,036.17) is provided to the bank as interest and the remainder 51.745% ($1,111.12) would go to principal.

Again, to be clear, I'm not saying that banks would like this or that they wouldn't drastically change their lending behavior if this were to become a regulatory demand, but I'm just showing how it could be done.

 

[finesse]

Wow. A mea culpa on this board from anyone is a rarity. @CFordUNC is the only one I know that regularly does that. You are a good role model.

Stayed out of the conversation because I had nothing to add but this is worth noting.

 

[Calheel]

Not necessarily, you could simply determine what the total interest at X.XX% of the total repayment amount would be and prorate each monthly payment according to that percentage. For instance (using a mortgage calculator):

On a $400,000 loan at 5% APR on a 30-year fixed rate, the monthly payment would be $2,147.29 and the total interest paid over those 30 years would be $373,023.14. Since $373,023.14 of the total payments to be made of $773,023.14 (principal plus interest) is 48.255%, then you'd simply say that each month 48.255% of each payment ($1,036.17) is provided to the bank as interest and the remainder 51.745% ($1,111.12) would go to principal.

Again, to be clear, I'm not saying that banks would like this or that they wouldn't drastically change their lending behavior if this were to become a regulatory demand, but I'm just showing how it could be done.

The problem with that approach (among several) is that 30 year loans don't last for 30 years. People either refinance or sell well before that. So, the bank won't have the opportunity to capture the lost interest. Now, you could simply say the interest is deferred, and have it paid back at the time of sale/refinance, but in that case, you are just playing a semantic game. Calling the payment "principal" and then back-filling the deferred interest at the time of sale means that you were never really paying principal in the first place.

So, the other alternative is just have the bank not collect the interest that is owed -- in other words, have banks subsidize the acquisition of housing by the public. Were the government to do that, the mortgage industry would become largely unprofitable and banks would simply stop lending overnight and the entire housing/mortgage market would collapse.

At a very practical level, you can't tell banks to make unprofitable loans. If you have a million dollars, and you have the choice between placing that in the stock market and getting a 5-10% return, or lending to home buyer for a 1% to 3% return, you are not going to lend to homeowners (or else, you are going to charge an exorbitant interest rate).

 

[SnoopRob]

The problem with that approach (among several) is that 30 year loans don't last for 30 years. People either refinance or sell well before that. So, the bank won't have the opportunity to capture the lost interest. Now, you could simply say the interest is deferred, and have it paid back at the time of sale/refinance, but in that case, you are just playing a semantic game. Calling the payment "principal" and then back-filling the deferred interest at the time of sale means that you were never really paying principal in the first place.

So, the other alternative is just have the bank not collect the interest that is owed -- in other words, have banks subsidize the acquisition of housing by the public. Were the government to do that, the mortgage industry would become largely unprofitable and banks would simply stop lending overnight and the entire housing/mortgage market would collapse.

At a very practical level, you can't tell banks to make unprofitable loans. If you have a million dollars, and you have the choice between placing that in the stock market and getting a 5-10% return, or lending to home buyer for a 1% to 3% return, you are not going to lend to homeowners (or else, you are going to charge an exorbitant interest rate).

Looking at the amortization schedule for the $400k/5% loan I reference earlier (I have it using the mortgage calculator from which I derived these numbers, I can post a screenshot if you want to see it), if someone were to sell their house after exactly 4 years/48 payments of $2,147.29 each month (total payments of $103,069.92), they would only have $25,480.00 in principal built up from that original $400k they borrowed and the bank would have made $77,589.92 on interest payments; which means the bank would receive 75.279% of the payments made just for loaning out money for 4 years. Based on prorating the interest across the life of the loan, the bank would still receive 48.255% of the payments made and the borrower 51.745%, meaning the bank would receive $49,736.39 and the borrower would have equity/principal of $53,333.53. For a whole lot of folks, they'd make the argument that receiving almost $50k in 4 years for loaning $400k (plus fees) is more than enough and that the bank is doing just fine with that amount, especially as the bank would now have their $400k back plus another $50k more to make other loans that they could use to make additional money.

As I've already given caveats about, I understand that such a regulation would greatly change bank behavior regarding loans because it would change the profitability calculation. But I also said from that for folks who don't really get into the details of financial instruments, that I can see why the idea of prorating interest would seem like a great idea.

 

[Calheel]

Looking at the amortization schedule for the $400k/5% loan I reference earlier (I have it using the mortgage calculator from which I derived these numbers, I can post a screenshot if you want to see it), if someone were to sell their house after exactly 4 years/48 payments of $2,147.29 each month (total payments of $103,069.92), they would only have $25,480.00 in principal built up from that original $400k they borrowed and the bank would have made $77,589.92 on interest payments; which means the bank would receive 75.279% of the payments made just for loaning out money for 4 years. Based on prorating the interest across the life of the loan, the bank would still receive 48.255% of the payments made and the borrower 51.745%, meaning the bank would receive $49,736.39 and the borrower would have equity/principal of $53,333.53. For a whole lot of folks, they'd make the argument that receiving almost $50k in 4 years for loaning $400k (plus fees) is more than enough and that the bank is doing just fine with that amount, especially as the bank would now have their $400k back plus another $50k more to make other loans that they could use to make additional money.

As I've already given caveats about, I understand that such a regulation would greatly change bank behavior regarding loans because it would change the profitability calculation. But I also said from that for folks who don't really get into the details of financial instruments, that I can see why the idea of prorating interest would seem like a great idea.

It is not about banks being greedy. It is about alternative uses of capital.

If one method of deploying capital only allows you to collect 47k and another method allows you to collect 77k, the capital will be deployed to the highest and best use.

You are borrowing all of the $500k at the outset of the loan. That means all/most of the $500k is tied up for the initial period of the loan. Why would financial institutions participate in a lending market in which they are only allowed to collect a portion of the FMV of their funds? They will deploy those funds to the highest and best uses, which may be hedge fund investments or similar. Or alternatively, they will charge absurdly high interest rates so that they net out to the same place as before the government intervention.