Friday, September 21, 2007

Why Is the 30-Year Mortgage Sacrosanct?

Maybe I'm being naive. Or maybe there's a lending rule I'm unaware of. But it seems to me that a lot of homeowners facing foreclosure would be well served if their lenders worked with them to refinance their debt over 40 years instead of 30. Why is the 30 year mortgage the gold standard?

Shailesh, I'm counting on your comments!

I suspect that the 30 year mortgage is based on olden days, back in the 1930's and 1940's (or 20's?) when home mortgages became common. Back in the day, folks lived in the same house for 30 years or more. Dad worked at the same company for 30 years until he retired. He probably started work at age 18 or 22 and retired with the house all paid off when he was in hid mid-50's. People didn't live past their late 60's, so this system probably seemed logical to everyone involved. (Remember, when Social Security was introduced with a retirement age of 65, the average life expectancy was 62.)

But times have changed. Almost nobody pays off a house through actual payments anymore. Americans are living to 80 and 90 and beyond. Most live in a house only 3 to 7 years before they refinance or sell (and pay off their lender).  And if the lenders are willing to lend huge sums of money on a 30 year mortgage, knowing full well that most borrowers will pay off the mortgage through a refinance or sale, then why not lend the same huge sum of money on a 40 year loan?  What's the difference?

Take your average $200,000 loan at 6.25% for 30 years. Payment is about $1231 a month. Stretch that out to 40 years and the payment drops over a hundred bucks to $1135. But let's get concrete. Let's imagine a real scenario (one based on a client of mine).  She's struggling to avoid foreclosure. Her mortgage was affordable, until the ARM interest rate adjusted.

Homeowner owes $200,000 at 8.125% and another $50,000 at 10.25%. Together, these are a $1933 per month payment. Before the rates adjusted, payments were in the mid-$900's per month. If the lenders both agree to extend to 40 years, and shave a little off their rates, the homeowner could see a drop of nearly $200/month in the payment ($200,000 @ 7.75% over 40 years + $50,000 @ 9.00% over 40 years). Two hundred a month is significant to this homeowner. It means the difference between holding onto her house, or facing a short sale.

Lenders would make more money in interest payments over 40 years than over 30. The buyer-borrowers could afford to stay in their homes. Lenders avoid the loss they almost always take when they foreclose on a home.

So why is 30 the sacrosanct number in mortgages