40 Year Mortgages – More Popular

by Mike Holman

Apparently new home owners here in Canada haven’t learned much from their American counterparts because 40 year long term mortgages are getting more and more popular.

According to a TD bank representative about 60% of first-time home buyers are opting for a 40 year mortgage which indicates that they are having a hard time affording the house and need to stretch the payments out in order to make the purchase.

I’ve been aware of these types of amortized mortgages for a while, but I was quite surprised at how popular they are. The optimistic side of me (yes, there is a little one there) likes to think that those 40 year people will make extra payments as time goes on and their income goes up. However, I realize that it’s just as likely that they will indeed take the full 40 years to pay the house off. That’s assuming of course that they don’t take any money out in the form of a home equity loan and of course that they don’t sell the house and “upsize” at some point.

Long term mortgages

I don’t think these mortgages are automatic passages to failure but they are very risky because if the homeowner has a decrease in income then they will have no room to lower their monthly payments by stretching the amortization which is an option that most people have. For example if you have 10 years left on a 20 year mortgage then if you had to, you can call the bank and get them to increase the amortization to say 20 years and that will lower your payments until you regained your income. If you are already on a long term or interest only mortgage then clearly you can’t lower the payments any more.

Another problem is increasing interest rates. Typically in Canada (unlike the US) we only lock in for a maximum of five years and many people like to have floating interest rates which are better in theory, but are too risky if you are maxing out your home payment. If a person or couple buys a house and can only afford a 40 year mortage at 6% then how will they afford a big monthly payment increase if the interest rate is 8% at renewal time?

Conclusion

Personally, I think if you can’t afford a 25 year amortization then you can’t afford the house. 40 year amortization and interest only loans are the same types of new “mortgage products” that recently got some of our American friends in home owning trouble.

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