Not so very long ago a car loan was usually taken out for two years and a mortgage for 20 years. OK, it was in the 1960s, but, honest, for some of us that was just yesterday.
Then car loans went to three years, to four, then to five and mortgages to a standard of 25 years for a very short time in the 1970s and have been at 30 years at least since the early 1980s.
These changes in amortization periods came about as both the price of new cars and homes and the interest rates increased. My memory may be off, but I think that the 30 year mortgage came into being around the time that interest rates were cresting in the high teens and the real estate market was at an absolute standstill. At that time the 40 year option also became available, and indeed is still available from some lenders. But once interest rates backed off of those historic highs, 40 years lost what little popularity they may have had. So few are written today, the Mortgage Bankers' Association does not even track them.
Obviously, spreading out payments over a longer period of time will make a loan, whether for a car or a house, more affordable to the consumer. Longer term loans also smooth out a bank or finance company's income stream. Even though most consumers don't drive the same car or live in the same house for seven years or 30 years, some do and the longer term loans (and outstanding balances that might have been paid off with two year auto loans or 20 year mortgages) may discourage consumers from a quick investment in new wheels or new bricks. Marketing and associated costs will also be much lower if the average customer stays with his loan for a longer period of time.
When interest rates started their steep decline in the early 1990s (from what were already reasonable rates, in the single to very low double digits), the length of both car and home loans stabilized and there has been, until now, little movement from what has become the five year and 30 year standard.
But recently car loans have been advertised with seven year amortizations (how else can the average person afford a $35,000 price tag). And here comes the 40 year mortgage, again.
Fannie Mae is now running a pilot program with 21 credit unions across the country to test-market 40 year loans. Credit unions typically serve a lower to middle income cliental, the population most likely to be receptive to such products.
While spreading out payments over a longer period of time means a lower monthly payment, it also slows the rate at which equity builds and substantially increases the total interest paid by a borrower over the life of the loan. Anyone who has received that jolt of sticker shock when the closing attorney read the figures of the HUD Trust in Lending statement and learned that their 140,000 house was going to cost them $300,000 in interest over thirty years is advised to meditate upon a 40 year term. Depending upon the size of the loan, it could add yet another $100,000 to that figure.
Then too, the interest rate itself may make the 40 year less of a bargain. The 15-year mortgage is now at 5.19 percent while the 30 year is 5.74 percent. It is fair to assume that lenders will price the 40 year mortgage at an additional premium. Assuming the same differential applies, the 40-year would probably cost 6.29 percent at a minimum.
Fannie Mae has no figures on the popularity of the new product, and admits that its timing was not good. The initiative was first unrolled in late summer when interest rates were on a steep but short-lived climb. The corporation speculates that the loan may appeal to the buyer who can't quite qualify for the home he wants under a 30 year scenario. Since most buyers do not stay in their original mortgage, either because they sell the home or refinance the loan, for more than five to seven years, a Fannie Mae spokesman said that the loan will help buyers get into a home today and then they can refinance as their circumstances change and allow them to qualify for a higher loan limit. The problem will be if interest rates rise substantially or house prices decline. This would leave the borrower locked into the long term loan.
Whether the 40 year pilot will be successful enough for Fannie to expand it to other lending institutions remains to be seen, but it has been widely panned by financial writers. Broderick Perkins, writing in Realty Times, lays out a hypothetical financial analysis of the plan, showing a 40 year loan saves little on a monthly basis and that a 3/1 ARM makes much more sense for the borrower who is stretching to afford a home.
And CBS Market Watch goes so far as to call the 40 year product their 'Stupid Investment of the Week.'