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Don't Fall for a 50 Year Mortgage!
Not Even for a Couple of Years
May 15, 2006

When I taught freshman math, I included a section on interest, in which I tried to give my students some understanding of personal debt and the National Debt. In one of my lectures, I talked about the relative costs of fifteen-year and thirty-year mortgages, and demonstrated that no mortgage longer than about twenty-seven years makes much sense. Back then, mortgages longer than thirty years weren't even readily available. I punctuated my point by explaining why: "Even real stupid people won't sign 'em."

Apparently I was wrong. Mortgage lenders are now offering fifty-year mortgages—and they are finding customers. Any way you look at it, this is financial insanity beyond comprehension. I guess the only part of my lecture that turns out to be false is that real stupid people apparently will sign 'em.

Many people start their house-shopping activity by determining how big a payment they can afford, usually based on how much they're currently paying for rent, or for their current mortgage. Then, they ask their real estate agent how much house that will buy.

Don't Let Your Real Estate Agent Decide What You Can Afford.
Now, some people are fond of bashing real estate agents, but I'm not. I personally think you're nuts to buy a house without an agent. Real estate transactions are complex business, and agents do them every day; you may only do them three or four times in your entire life. But your agent is not the person to tell you how much house you can afford—that's your job.

It's OK to ask your agent how much house your planned payment will buy, but ask more than that, and make your own decision based on the answers. Start by asking how much house you can get with a fifteen-year mortgage, with a thirty-year mortgage, and with a fifty-year. Then ask to see an amortization schedule for each of those loans. The schedules will show you how much of your principal you will pay off each month, and how much you'll still owe.

An Example
Suppose you're a first-time home buyer, and you've been paying $800 per month for apartment rent. You have good credit, and just got a nice promotion at work, so you think you could make a $1000 per month payment on a condo. You've been saving, and have a $25,000 down payment in the bank. So you look at how much you can borrow with each type of mortgage:

6.0% Fixed Interest
Mortgage amount, $1000/mo. payment

Down Payment
Less origination and other costs
Price of House

At first blush, that 50-year mortgage certainly looks interesting. You can borrow $71,464 more money, with the same monthly payment.

The Total Cost of a Loan
But look deeper. The first thing to investigate is the total cost of each of those mortgages. That's a simple calculation; just multiply the payment amount by the number of payments. Add in the origination and other costs if you want to.

# of Payments
Payment Amount
Origination and other costs
Total Cost of Loan

Woops! Can that be right? Yes, you'll pay $420,000 more for that additional $71,000 worth of house. You'll pay 567% more interest on the fifty-year loan in this example than on the fifteen-year loan—and you only get 51% more house.

"But," you say after you start breathing again, "I only intend to keep this house for five years, so it won't be so bad, right? Well, let's look. This table compares the mortgage equity you'll have in each loan at the end of five years and ten years:

Amount of Principal Paid Off

This is the amount of the loan you will have paid off. We might call it the mortgage equity. (It's not the actual equity in your home, because it doesn't include appreciation—the increase in your home's value. We'll look at that in a minute.) But the problem with that fifty-year mortgage is clearly evident here. At the end of five years, you'll have paid off only $3500 of your home loan, as opposed to $28,000 if you have a fifteen-year loan. At ten years, the difference is even more scary: about $8,000 as opposed to nearly $67,000. Averaged over the first ten years of this 50-year mortgage, only $68.50 per month of your $1000 house payment goes into your pocket. The first month, it's only about $50. All the rest is interest.

This graph clearly shows what's happening. Look how slowly the mortgage equity grows in the early years of a long mortgage. With the fifty-year loan, it takes more than eighteen years to pay off $20,000! By that time, you've paid almost $200,000 in interest.

Your Equity
Now let's estimate your actual home equity by adding in appreciation and the $25,000 down payment. Nobody can predict how much your home will increase in value over the years. Much depends on its location. But with inflation running at 3%-4% in recent years, let's guess that your house will appreciate at 4% per year.

Full Home Equity @ 4% Appreciation

Well, the differences aren't as extreme now, but at the end of five years, you'll still be almost $9,000 better off with a fifteen-year mortgage than with a fifty-year, and at the end of ten years, about $24,000 better off. And remember that if you're going to sell this house to buy a better one, that next house will have appreciated as much as this one. You'll be selling and buying in an inflated market. So the previous chart, showing your mortgage equity may provide the better comparison.

Your Tax Deduction
But what about taxes? You get to deduct home loan interest from your taxable income. I'm amazed at the number of people who seem to think that a tax deduction goes entirely into their pockets. Actually, the only part of a deduction you get is the portion on which you would have paid taxes. So if you are paying your federal income taxes at the 25% rate, and you get a $100 deduction, that actually reduces your tax bill by only $25. Remembering that you only get to deduct the interest amount, not your entire house payment, let's now look at the difference in the three loans:

Full Equity + Tax Benefit (25% tax rate)

You might also get a small benefit on your state income taxes, and you can deduct your property taxes, but those deductions will be smaller than the federal benefit on interest—and you can see that it didn't change the picture much. At the end of ten years, you'll still have almost $10,000 more value with a 15-year mortgage than with a 50-year. Note that the differences here are not so great at five years. That's because you're paying so much more interest during the first years of a long mortgage than a short one—and you can deduct that interest. I added the fifteen year numbers to this table so you can see how much the difference widens by that time. Of course, if you keep a fifteen-year mortgage for fifteen years, it's paid off. The property is all yours.

There's another factor that I didn't include in these calculations, and that is that you'll actually pay higher interest rates on longer term loans. As I wrote this piece, the national average for fifteen-year mortgages was 5.86%, and for thirty-year loans was 6.20%. The source I used isn't yet quoting national averages for fifty-year notes, but they'll be higher than for thirty-year. That just makes all of these comparisons a little more extreme.

So, are there ever any circumstances where the phenomenally high interest costs of a 50-year mortgage make sense? I can think of two. One is when housing prices are soaring—growing at a percentage rate considerably higher than the mortgage interest rate—and very likely to remain at those high levels for the time you expect to hold the mortgage. Under these circumstances, the appreciation on the bigger house will earn you more than the cost of the exorbitant interest. The second situation where a fifty-year mortgage might make sense is when you're actively investing your money at yields a couple of points higher than mortgage interest rates, and you expect to be able to do that for as long as you hold the mortgage. Of course, if you're really that investment savvy, you already knew everything I've said in this article, and quit reading long ago—and you're probably not buying a $140,000 house, either.

Even in these situations, the gain you might realize after paying interest during the first years of a fifty-year mortgage will be small. In most circumstances, the loss you experience will be significant.

The House You Can Afford
For most people, the final answer is simple: The house you can afford is the one you can afford with a fifteen-year mortgage. Your real estate agent and your lender would rather you buy a bigger house, and will try all manner of justifications to convince you that you should. But unless you are absolutely positive that one of the above exceptions applies to you—you will always come out ahead with a fifteen-year mortgage.


copyright © 2010, J. C. Adamson