It was once a real goal for homeowners to pay down their mortgage faster and build equity in their homes for future financial stability. New mortgage plans offer longer amortization periods, extending the traditional 25 years by an additional 5 to 10 years. These products are designed to allow greater affordability and may help some first time buyers to afford a home. Consumers can make their monthly mortgage payments smaller which allows them to get into the real estate market sooner, or afford a more expensive house.
This sounds great at first glance, but extending amortizations does not lower monthly mortgage payments significantly and, most importantly, the amount of money from each payment that is used to reduce principal owing is small. Sure, lower monthly payments sound wonderful, but the downside is that those payments go on and on and the interest bill becomes much bigger.
Here's what it looks like: A $200,000 twenty-five-year fixed mortgage at 5.2% carries a monthly payment of $1,186. Make it a 30-year mortgage and the monthly payment drops by close to $100 to $1,091. At 35 years, it drops to $1,029. It looks like you just 'saved' $157/month with the longest mortgage. But take a look at what happens to the interest!
With the same $200,000 mortgage amortized over 25 years, you would pay back about $356,000 by the end if the interest rate stayed the same. The total payback with the 35 year mortgage goes up to almost $432,000- that's an extra $76,000 in interest! Or, to put it another way, at the end of year 25 when the typical mortgage payer is sending in the last payment, the holder of the 35 year mortgage would have barely paid off half of the mortgage principal.
With a 30 to 35 year mortgage, borrowers are in the position of paying plenty of extra interest- probably in the tens of thousands of dollars- and plus they have to pay higher insurance premiums. Future financial flexibility can be limited as well when mortgage payments last into retirement.
This point is typically countered by the fact that borrowers can always reduce interest costs by making lump-sum payments against their mortgage in addition to their regular payments- but, in reality, how many people ever do this?
Meanwhile, homeowners with substantial equity in their homes are using that equity to set up lines of credit to use for other investments- the stock market, a rental property, renovations or debt consolidation.
New mortgage options help sustain the housing market in the short-term by improving affordability, but how can the economy continue to grow if everyone is using their money to pay down debt?
Tammy Dufault*
Century 21 BJ Roth Realty Ltd., *sales rep.
