Yesterday, I received an email from a friend who is moving into a new home that he’s financing with a fifty year mortgage. He was bragging about how low his payments were and he’s putting equity into his house. For regular readers of this site, it shouldn’t be a surprise that I quickly loaded up my spreadsheet of choice and got down to business looking at the numbers. If you’d like to play along at home, here’s my favorite online mortgage calculator.
First of all, according to this article, fifty year mortgages are typically 5/1 ARMs with a quarter percentage point higher than a 30 year loan. What does that mean? Over the first five years of the loan, the borrower will pay about 0.25% more than a typical thirty year fixed rate mortgage, but after that, the rate adjusts annually to match the prime lending rate.
Since we have no idea what will happen with interest rates five years down the road, the only way to really evaluate such a loan is over the first five years of the loan. Let’s take a look.
Let’s say that we’re buying a $250,000 home and we have a $50,000 down payment. We can either take a 30 year loan at 6%, or a 50 year loan at 6.25%.
Monthly payments With the 30 year mortgage, your monthly payment would be $1,199.10. With the 50 year mortgage, your monthly payment (for the first five years, as mentioned above) would be $1,089.95. The obvious winner here is the longer term mortgage; even with the higher interest rate, it is cheaper per month. But the news gets bad from here on out.
Equity in house after five years Let’s say that in five years you’re ready to sell the house and move on. We’ll also assume that your house value went up 10%, so now it’s worth $275,000. For the thirty year mortgage, you still have a balance of $185,840, which means that you now have $89,160 in equity in the house. On the other hand, with the fifty year mortgage, you still have a balance of $196,544, which means you have only $78,456 in equity in the house. With the thirty year mortgage, you have $10,704 more in equity after five years.
Now, the difference in your monthly payments is $109.15, so over sixty months, you’ll pay $6,549 more with the thirty year loan, but you end up with $10,704 more in home equity. That’s a 63% return over five years, or about 11% a year. I don’t know about you, but if I can afford an investment that returns a guaranteed 11% a year, I’m quite willing to dump $110 a month into that investment.
In short, a fifty year mortgage simply isn’t worth it. A thirty year mortgage is actually an extremely good investment versus a fifty year, and we’re not even considering the bad things that can happen when your rate adjusts with the fifty year. There’s pretty much no reason to ever consider getting a fifty year mortgage unless you enjoy handing a lot of money to your mortgage company with nothing in return.