How would you feel, if someone added another 10 years to your mortgage?
(Or, if you don't have one, or have paid yours off, let me ask it another way: How would you feel about signing up to pay off a home over 40 long years?)
Because that's the offer being made by finance company, Pepper Money, which is rolling out a brand new 40-year mortgage.
That sound you just heard is my brain exploding.
Now, let's deal with why it's being offered.
Here's how The Australian's Wealth Editor, James Kirby, put it:
"One of Australia's biggest non-bank home loan lenders, Pepper Money, is launching a mortgage next week that will run out to December 2065.
"Offering borrowers longer terms for mortgages allows them to pay less per month. On the flip side, the loans are considerably more expensive over the longer term."
Indeed, in that same article, comparison site Finder's data is cited, thus:
"For the average home loan borrower with a $625,000 loan, a typical extra 5 years meant an extra $147,000 which had to be paid to the bank over the extended life of the loan, but ongoing payments fell by around $183 per month."
Bear in mind, that's 5 more years.
And that's the average loan, meaning many, many people are paying even more.
And Pepper is offering to extend the mortgage term by not 5, but 10 years.
It's not easy to do the maths yourself, by the way: the first dozen loan calculators that Google served me up wouldn't let me use more than 30 years.
So… I did it myself, and check out these numbers.
If you borrowed $625,000 at 6% for 30 years, you'd pay:
$3,747 per month
$724,000 in interest
$1.349 million in total repayments
Reckon that's a lot?
Check out the numbers over 40 years:
$3,438 per month ($308 less)
$1.025m in interest ($302,000 more)
$1.651 million in total repayments
Yep, you'd pay more than $1 million in interest alone, on top of the repayment of the principal..
And more than $300,000 more than a 30-year term over the life of the loan!
I don't know about you, but I reckon that's a lot to pay, just to save $308 per month!
But wait… there's more.
See, this probably gets a lot worse.
Before we get to that, let's remember that proponents of this sort of loan would say it increases access for those who don't have the monthly income.
Which is a little bit true. Only a little bit? Well, yes – I doubt there are many who could afford $3,438 per month, but not $3,747. Meaning the size of the group that this 'helps' is small.
(Oh, and remember: the financial institutions benefit from all of that lovely extra interest. It's possible that's part of the motivation…).
So, the 'it gets worse' bit?
Well, we know that buying a house is a competitive process. That's most obvious at auctions, but it happens for private sales, too – the agent and the seller set the price as high as they think the keenest buyers will pay.
Now, let's go back to our example.
Let's say the person who can currently pay $3747 a month (and who would currently take a 30 year loan) goes to a banker offering a 40 year mortgage.
Here's what happens now:
Would-be buyer: "Excuse me, I can afford to repay $3,747 a month. How much can I borrow?"
30-year-mortgage banker: "Based on that affordability, I can lend you $625,000".
And when there are 40 year mortgages? It'll go like this:
Would-be buyer: "Excuse me, I can afford to repay $3,747 a month. How much can I borrow?"
40-year-mortgage banker: "Based on that affordability, I can lend you $680,000".
Sure, some people will just take a 30-year mortgage and borrow less.
But most people?
Well, here's one I prepared earlier: Standard mortgage terms used to be 25 years. When was the last time you heard of a borrower who asked the bank to calculate their borrowing capacity over 25, and not 30, years?
Exactly.
Once 40 years becomes the standard loan length, everyone will use it by default. And the person who asks the bank for a 30 year mortgage will take their $625,000 loan with them when they try to buy a house, only to be outbid by those with longer mortgage terms and $680,000 in the back pocket.
In other words?
In other words, this approach which is supposed to help 'affordability' is very, very likely to result in:
– Monthly repayments remaining the same
– Loan terms being longer
– Total repayments being much higher
– Interest bills being much higher
– House prices being much higher
… and those who can't afford the current 30 year mortgage being locked out of the market, just as they are now.
Oh, and finance company profits being higher. Funnily enough.
How's that for a neat trick?
Seriously, this isn't an affordability measure. At best it's a well-meaning mistake and a sign of desperation from buyers who feel locked out of the housing market.
But, as I've hopefully shown, 40 year mortgage terms would be a disaster for everyone except banks and sellers – two groups who are entitled to make a buck, but who don't need the generosity of first home buyers.
This is one 'innovation' that should be nipped in the bud… before it becomes the norm.
Fool on!
