Apparently new home owners here in Canada haven’t learned much from their American counterparts because 40 year long term mortgages are getting more and more popular.
According to a TD bank representative about 60% of first-time home buyers are opting for a 40 year mortgage which indicates that they are having a hard time affording the house and need to stretch the payments out in order to make the purchase.
I’ve been aware of these types of amortized mortgages for a while, but I was quite surprised at how popular they are. The optimistic side of me (yes, there is a little one there) likes to think that those 40 year people will make extra payments as time goes on and their income goes up. However, I realize that it’s just as likely that they will indeed take the full 40 years to pay the house off. That’s assuming of course that they don’t take any money out in the form of a home equity loan and of course that they don’t sell the house and “upsize” at some point.
Long term mortgages
I don’t think these mortgages are automatic passages to failure but they are very risky because if the homeowner has a decrease in income then they will have no room to lower their monthly payments by stretching the amortization which is an option that most people have. For example if you have 10 years left on a 20 year mortgage then if you had to, you can call the bank and get them to increase the amortization to say 20 years and that will lower your payments until you regained your income. If you are already on a long term or interest only mortgage then clearly you can’t lower the payments any more.
Another problem is increasing interest rates. Typically in Canada (unlike the US) we only lock in for a maximum of five years and many people like to have floating interest rates which are better in theory, but are too risky if you are maxing out your home payment. If a person or couple buys a house and can only afford a 40 year mortage at 6% then how will they afford a big monthly payment increase if the interest rate is 8% at renewal time?
Conclusion
Personally, I think if you can’t afford a 25 year amortization then you can’t afford the house. 40 year amortization and interest only loans are the same types of new “mortgage products” that recently got some of our American friends in home owning trouble.
24 replies on “40 Year Mortgages – More Popular”
I am not sure I really understand all this fear of 40-year mortgages… I mean, I bought a house last year and I could not afford a 25-year mortgage (I’m single and only one income), so I went for the 40-year one. Anyway, I opted for weekly accelerated payments and right away my mortgage went down to 27 years! Since my mortgage has a variable rate, it went down even more with the latest cuts and now I am looking at a 22-year mortgage. So, although I agree that taking 40 years to pay a mortgage is “too much”, I really cannot see people taking THAT long. And if you can increase your payments yearly, it goes downs even more. So, my point is, are people REALLY taking 40-years to pay the mortage?
A 40 year mortgage could be great for a real estate investor. Its close to an interest only mortgage (keeping the bulk of the mortgage payment deductible and keeping your cash reserves liquid), but I *BELIEVE* the fees are lower (does anyone know for sure?).
I totally agree that they’re misused in the vast majority of cases.
Of course, if you’re financially responsible then theoretically a longer loan term would be better because you’d get more leverage. Most people aren’t financially responsible, unfortunately.
I think my brain is wired differently than most. I see 40-year mortgage and think “indentured servitude.” While many of my Vancouver friends see me as the loser for renting. Rent is FAR less than half the cost of interest payments in Vancouver. I have no clue if these “mortgage lifers” have looked at an amortization table to comprehend how little principal they pay each month. Makes me sad, actually.
We have 25 and it seems like that’s eons away. My siblings have 20s in Irelanbd, which is much more challenging given house prices and cost of living there. But I can’t tell you how often I’ve seen parents of some of my 20- and 30-something peers ask them when they’re going to buy a house. Yes, yes, they’re big boys and girls but enough years of that and general culture beyond your family telling you you’re a big loser for not buying, and maybe you buckle and get the 40 year mortgage. Parents – do not do this to your kids!
IMO, this marks the top of this real estate cycle as the banks are now attempting to provide affordable housing options to consumers that would otherwise not quality or be able to pay mortgage payments on a 25-year term. Pretty much “everyone” has bought in the past few years and upgraded leaving new homeowners in their wake. If you did pay a mortgage over 40 years you’d essentially be paying for two homes: one just with the principal and the other just with interest. Of course you could re-finance after 5 years if your income or situation has changed, but these 40-yr mortgages aren’t being held by 20-30% down….more like 5% as a minimum.
Trouble indeed!!!
On a 40 year mortage at 5% the first payment is 86% interest, 14% principal. The first payment at year 10 (or the 120th payment) is 77% interest. At the half way point, you’re still paying 62% of your payment for interest.
At half way, you’ve paid off less than 30% of the principal. By the end, total payments add up to 230% of the loan amount.
After 5 years you still owe 95K. If at that time you have to refinance at 5.5%, your first payment will be 85% interest. If you need your payment to same the same (with the .5% higher interest rate) you’ll need an amortization of 42.5 years!
If the rate goes up to 6% and payments need to stay the same, you need a 65 year amortization.
These things are garbage.
No inflation included in my post above, so things are slightly less painful than they look (but not much).
As a mortgage broker, I want to clear up something about this post. You state that “about 60% of first-time home buyers are opting for a 40 year mortgage which indicates that they are having a hard time affording the house and need to stretch the payments out in order to make the purchase.”
While it’s true that more and more of my clients opt for the 40 year option, they still need to qualify at a 25 year amortization. If they qualify at a 25 year amortization, then they have the option to stretch payments out to 40 years if they choose.
While there are many “interesting” ways to attempt to get someone to qualify for more mortgage, simply stretching out the amortization is not one of them.
I personally have a 40 year mortgage. Being self employed, I wanted to keep the payments down so that during lean times my payments would be less. During busy times, I can accumulate a little cash and then make a nice lump sum payment.
Saying that, most of your post is bang on. I’m a RSS feed subscriber, and enjoy what you have to say. Nice job.
And to Mr. Cheap about his comment on fees being less for 40 year mortgages. Actually the mortgage default insurance fee goes from 2.75% on a standard 25 year mortgage to 3.35% for a 40 year product. It goes up 0.2% for every 5 additional years.
I am against 40 year mortgages but the argument is that with interest rates being so low you might as well keep your monthly payments low and use the money for something else. Of course, if the Feds start raising interest rates again…
Al, thanks for the calculations… OUCH!!!
This makes me wonder if banks are pushing for longer term by promoting smaller payments the way car salesmen show you monthly payments as a selling strategy instead of the total price (See different posts on car purchase).
With the median house price in Vancouver over $700,000 it’s not really a surprise that 40 year mortgages are becoming so popular.
I just looked on mls.ca and the cheapest house for sale in Vancouver proper is currently an amazingly low $388,000. It’s a 78 year old 2 bed, 2 bath home and is being sold for basically lot value. (If you want to look it up, it’s MLS#V689623.)
The house is only 1,095 sq ft with an unfinished basement on a tiny 25×99 lot in a bad area north of Hastings Street and probably the most stunning thing about it is that it’s currently rented for $1,500!
When a place like that commands a $1,500 rent you can understand why people are willing to pay around $700 k for a 1970’s Vancouver Special in decent condition and in a tolerable neighbourhood, even if that means taking a 40 year mortgage.
Nelson Smith: Thanks for your response, good to get it “straight from the horse’s mouth”! I was actually asking how the fees on a 40 year compared to the fees on a interest only mortgage (i.e. which is cheaper)? Sorry if I was unclear…
here’s a trick: I had 7 years left on my mortgage. I changed the amortization to 35 years, and I’ve been doubling up my payments every 2nd week.
Why? because pre-payments go straight to the principal, while regular payments go to the interest, then the principal.
Hard to believe, but I will pay off my mortgage faster that way! and my monthly payments are only slightly higher than they used to be!
(PS: I have an open mortgage, so i prepay additionally when I can: tax refund, year-end bonus, whatever.)
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My spouse and I are looking at building a home and will probably get a 40 year mortgage to do so.
The mortgage will likely be in my name only as my Wife is only currently working part time and has student debt to deal with. However, I do intend to do some sort of accelerated payment plan and my Wife is planning on finding more steady work.
I don’t look at owning a home as a financial investment. Renting where I live has become more difficult and more expensive. All I want is a stable environment for my family and I will do whatever I need to do to achieve that.
Agatha: Good point, however what makes you say you couldn’t afford a 25 year mortgage if you were able to afford the accelerated payments? The fear for 40 year mortgages are people who have to stretch to make the normal payments on it. If you can easily afford more then the monthly payments, then you’re right, a 40 year mortgage is a safe, reasonable option.
Congrats on pulling down your amortization period so dramatically!
Mr. Cheap: Well, when I applied for my mortgage I was not approved for a 25-year loan and the only option would be the 40-year one. When I signed the papers at the bank I asked for weekly payments because I prefer like that, they told me about the accelerated option and it was not too much more. So I did that and the mortgage period went down right away.
🙂
Weird. I think Canadian Mortgage Trends recently said that the only way to get a 40 year amortization was if you were approved for a 25 (i.e. what happened to you wasn’t possible). Guess it is! 🙂
Good for you for attacking it aggressively in any case!
Hi Mr. Cheap,
Just to clarify…
There are some lenders that won’t allow you to get a 40-year amortization unless you qualify for a 25-year.
There are others that let people qualify with a 40-year am. For better or worse (we’re not big fans of it), this is done regularly to get people into a mortgage they could otherwise not afford. This is why 40-year ams have propped up the real estate market like they have.
Cheers,
Rob
Rob: Gotcha, thanks for clarifying!
Why stop at 40 year, why not 50 or 60 or 100? People rarely live in a home more than 7 years anyway…
Ron – true, if someone is moving every 5-10 years and changing the amount of the mortgage then the amortization is fairly irrelevant.
Mike
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