Wednesday, January 10, 2007

The Gong Show #1 - 40 Year Mortgage

If you aren't familiar, the Gong Show was a television variety show spoof that was broadcast from 1976 until 1980. Each show presented a contest between amateur performers of often dubious talent, with a panel of 3 celebrity judges. If the judges considered an act to be particularly bad, they hit a gong to end it immediately.

I am introducing what I hope to be a regular Thursday post called "The Gong Show" in which I will feature a dubious financial product that I think deserves to be gonged. There are many financially suicidal products out there so I have a feeling that I won't run out of material any time soon.

For this weeks gong show I am featuring the 40 year amortization mortgage. Available at most Canadian financial institutions and mortgage companies now, the 40 year mortgage is certain to get the gong from prudent financial managers who think that enslaving yourself to a mortgage is not a good use of the freedom we enjoy in Canada.

Lets see, if you purchase your first home at age 30 and because real estate prices are so nuts the only way you can afford the monthly payment is by going with a 40 year mortgage, you will be paying off your home until age 70. Hmmmm . . . . well, gosh, golly, I never knew it could be so good, sign me up!

What do you think? Should the 40 year mortgage get the gong? Why?


mohican said...

Caveat: I am not saying that these products should be banned or something. I just think that the average Canadian should not use them. Its a personal decision and I will defend the individual's right to choose whatever financial product they feel is best. I really just don't want these products pushed on unsuspecting people by pushy mortgage salespeople.

Jojuchst said...

What if a university grad made a purchase as soon as he gets out of school and finds a decent paying job? He would only be slaved till he's 62. 50K annual salary would float a 40 yr amortization 300K mtg @ 5% with monthly payment of $1500. Amortization term can always be renegotiated at renewal time don't forget.

Not for everyone obviously but for someone who's determined and thinks long term the value of the purchase is there then a 40yr amtz mtg could put him in the market sooner.

With a long term view the sooner you're in the market the better off you'll be.

the pope said...

With a long term view the sooner you're in the market the better off you'll be.

Usually, but what if you graduated in 1981 and bought a house then? You'd be in the market sooner, but one year later the same house would have required half the debt you took on. The same goes to a varying degree to buying at any market peak.

Mohican: great idea for a regular subject, I also think the wednesday post about investments would be great - You're experience in financial planning is your niche and its what keeps me coming back.

mohican said...

"With a long term view the sooner you're in the market the better off you'll be."

I disagree with the premise of your argument. With a long-term view the potential purchaser should realized that they will pay more in interest over 40 years than the property was originally worth.

For example, imagine your hypothetical university grad who has his or her act together and is making a solid living wage. Assuming 25% down ($100,000) on the purchase of a $400,000 home (somehow this student managed to save an amazing amount during college and have no other debts). Say this person takes out a 40 year amortization on a $300,000 principal. He/she pays $683 biweekly, $587 of which is interest - ie money he'll never see again.

Over the term of the mortgage this person would pay (assuming a 5.25% rate) a total of $413,000 in interest payments alone giving him a total payment for his $400,000 pad of $813,000 plus taxes, strata, heat, light, etc, etc.

Question here is how much rent would this person have paid over the same period? By my calculation, if this same person rented the same place over 40 years he would pay the same in rent as interest but he would be saved the costs of property taxes, utilities, etc. Lets say $4000 / year plus having $100,000 earning interest - another $4000 / year.

mohican said...

Regarding 'long-term' real estate prices, I draw your attention to this post at VHB.

littlemanrenter said...

Interesting post. Though being in that demographic... I would say if someone told me that I could be in owning mode with $1500 a month - then you have my interest (interest of mind)

One of things assumed here is that I will actually live in that place for the full 40 years. This is unlikely.

I think people end up getting convinced with the 'you pay for about 5 years, or less, or maybe more' but then the RE boom cycle kicks in again and you sell the place, hopefully make your small bit of profit and move on (yes - there's the question that you'll lost the profit on your next purchase as you're buying in a boom but some play it a bit smarter and wait until the next bust)

Don't get me wrong, I am not a fan of 40 year mortgages and they are basically an excuse to cover for poor affordability - I'm just saying this is what the mentality is of the FTBers out there.

They do not have the years of experience and wisdom that others do. They only have what their friends and co-workers are doing and feel the need to keep up.

Short term - it sounds great but its not

Uncertain Buyer said...

Boy have times changed. I'm saying this in my early 30's?? I thought I would be at least 50 before thinking this way.

I remember, that 25 years seemed like a life time to pay off a mortgage. When I got mine it scared me half to death to have a $1400/month payment for the next 25 years. Not to mention when, not if, interest rates go up.

I work with a lot of people who are retiring and close to retirement. Their advice is to get that damn mortgage paid off as soon as possible. The freedom of not having a mortgage is amazing.

Uncertain Buyer said...

I don't want to get personal here, but I just can't help it.

It seems like the younger generation is being put into this massive debt to buy over inflated Real Estate off of a retiring generation. Who in turn is going to enjoy the rewards of all this newly acquired equity in their homes.

As they Golf we will paying for it for the next 40 years. Kind of Piss' me off.

I hope we wise up and back away from these rediculous prices. If people wise up and stop buying for awhile then there will be a down turn in prices.

littlemanrenter said...

I hear what you're saying but I don't think its all bad. That is - if its manageable debt.

True finances and money management is not taught in high school and traditionaly by the time most people get to the mortgage or house buying stage, they are married or going to that stage and I think it was looked at more as a stage in life rather than a finacial step.

That has changed a bit but I really wish I was taught more about it before I left home so I could actually get a better jump on the benefits.

Paying rent sucks - vs paying a mortgage. You can always try to sell... or rent it out if you need to change, but at least your money is going somewhere.

Now... that being said, you're right, I think way too many people in their 20's are looking at the Bob Rennie pamphlets, seeing people drive fancy cars and everyone talking about buying RE that they don't really think about the ramifications and if they in fact can afford it...

What happens happens and you can only take care of yourself. I am trying to make up for lost time but I will say this... many thanks go out to the blogs that have started. Had I not come across them and learned much more than I probably would be looking at a mountain of debt as opposed to saying "hmm... wait a minute... what is the best way to go about my finances?"

its slow going but eventually people learn

Freako said...

"Paying rent sucks - vs paying a mortgage. You can always try to sell... or rent it out if you need to change, but at least your money is going somewhere."

It probably feels that way, but since renting is cheaper than owning at present, you would accomplish the same thing by investing the savings somewhere else (an RE REIT for all I care). In fact, more of your money is working for you as for SFH, renting is cheaper than the ownership. The difference of course, is that an owner has leverage price exposure - which can be a very good thing or a very bad thing. Of course, nothing stops the renter from similarly exposing his "savings".

The real benefit of ownership really are the intangibles (pride etc). Of course, these are personal preferences. Some people MUST own at any price, others are indifferent or even adverse to owning. To each his own. Straight financially, there is no advantage to owning a home. Unless you are so irresponsible that you need forced savings of a mortgage. But anecotally, I think the situation has reversed somewhat. Renters are fiscally responsible and recent owners are reckless.