People should be careful about very long term mortgages

[_OkGo_]

Hi Brendan,

One thing that many consumers overlook in this decision is the term length and they do not understand how compounding works. Lots of people are offered 35 year terms because it makes the monthly payment look good but it ultimately costs them a significant amount of money. Fixing for 5/7/10 years with a 35 year term is not a good idea if you don't intend to overpay either during the term (if allowed) or by lump sum at the end of the term.

This is about the only time it makes sense looking at the total interest paid over the life of a mortgage. Even on Avant's new 1.95% rate, the difference between 25/35 years is huge. Much more significant than occasional switches. Ideally consumers do both, switch and accelerate payments

Term	Interest rate	Total interest (300k mortgage)
20	1.95	€62.5k
25	1.95	€79k
35	1.95	€114k

 

[Brendan Burgess]

Hi OKGo

I have to fundamentally disagree with you. This is not the way to look at mortgages.

If I rent a car for two weeks, I will pay more than if I rent it for a week.
If I rent a €60k car, I will pay more rent than if I rent a €20k car.

There is nothing magic about a mortgage. It is renting money.

If I rent money over 35 years,of course I will pay more rent than if I rent it for 20 years. I have the use of the money for longer.

You should never look at the total interest over the period of a mortgage.

It's meaningless. It's confusing. And it makes no allowance for the present value of money which is the other side of your compound interest coin. So in saying that you will pay €114k interest over 35 years, you are making a 2020 euro the equivalent of a 2055 euro. It is not.

It may well be better to pay a mortgage over 35 years than 20 years, if you are putting the difference into your children's education or a pension fund.

If you have a buy to let property and a cheap mortgage rate, it may well be right to have an interest only mortgage.

Compound interest works on both borrowings and savings. If I pay my home loan over 35 years, sure I will be paying more interest. But if I have put the reduced payment into a pension fund, I will have a tax-free fund accumulating also at compound interest.

When comparing mortgages the main issue you should look at is the mortgage rate, as adjusted for any cash back or upfront fees.

Maybe that is the point you are making?



I am a big fan of paying down one's mortgage

The key point in this response is to point out that looking at the cost over 35 years vs. 20 years is wrong.

But I am still a big fan of paying down one's mortgage to a comfortable level as quickly as possible. And my idea of comfort is 50% LTV and one time your salary.

It's probably right to take out the longest term possible on your mortgage
If you take out a 20 year mortgage and get into difficulty, you will be classified as being in arrears.

If you take out a 35 year mortgage and make the same repayments, you would be classified as a prime customer.

I suggest to people to take out as along a mortgage as possible and then overpay it as if it were a 20 year mortgage. If you get into difficulty, you can reduce your repayments.

 

[NoRegretsCoyote]

A 35-year mortgage for a 27-year old with a steady career track is not a problem at all.

Tax-relieved pension contributions will almost certainly give a better return long-term than paying a mortgage quicker over, say, 25 years.

I got a 30-year mortgage when I was 31 and it was the right option. Allowed me to afford a bigger house than a shorter term would have and I will still have it paid off by retirement.

 

[DublinHead54]

It is useful to know that information, but are we really taking out a 25,30 or 35 years mortgage on Day 1 at that rate? We generally enter into fixed rate mortgages of <10 years e.g. 2 years. The information you have provided is the difference in interest costs based on today's rate over 25,30 or 35. In addition, I would need to predict what the interest rate is going to be in 2 years from today (forward rate) and then the interest costs over 23, 28, 35 (Term - Fixed Period), repeated for each fixed term period until the mortgage would complete.

Interest rates could go up or down, I can't predict 5 years out so I am not going to be able to predict 30 years out. Therefore I think the simplest thing to do is to minimize the monthly costs of the mortgage.

 

[_OkGo_]

There are only 3 variables to the cost of a mortgage: Principal, interest rate and Term length.

• Central bank limits were introduced to protect consumers from over borrowing on the principal
• It always makes sense to have the lowest available interest rate (usually achieved by switching)
• Term length is just as significant contributor to the cost but there are no rules to protect consumers other than it must be ends at 65, i.e you can only get a 35 year term at 30 yrs of age

If you show the average consumer the equation as below, they will not understand it. Showing them the interest figures (while not perfect) demonstrates that a shorter term saves them money regardless of the interest rate they are on

Total Cost = (N . P . r) / (1-(1+r)^-N)
N = term (in months)
P = Principal
r = interest rate (monthly)

I got a 30-year mortgage when I was 31 and it was the right option. Allowed me to afford a bigger house than a shorter term would have and I will still have it paid off by retirement.

This is the point that I am making. It may have worked for you and you probably had a financial plan to contribute to pensions etc and make use of the monthly difference, all very sensible and prudent. But for the average consumer who does not think like you, they only see the reduced monthly figure and believe it is more affordable when it is not. If you can not afford the 25 year payment, that should be a red flag that you are over borrowing and a 30-35 year term does not fix that

It's probably right to take out the longest term possible on your mortgage

Yes I agree, I am not against longer terms ( I have one myself) but everyone needs to have a personal strategy to pay it down at a more sensible rate of 20-25 years. The lower minimum payment of a 35 year term is a great buffer to have if/when needed

It's meaningless. It's confusing. And it makes no allowance for the present value of money which is the other side of your compound interest coin. So in saying that you will pay €114k interest over 35 years, you are making a 2020 euro the equivalent of a 2055 euro. It is not.

It may well be better to pay a mortgage over 35 years than 20 years, if you are putting the difference into your children's education or a pension fund.

PV is not as significant as 2020 vs 2055, both examples run concurrently so the difference is 10 years. Equally a pension pot figure does not include a PV/FV

But I am still a big fan of paying down one's mortgage to a comfortable level as quickly as possible. And my idea of comfort is 50% LTV and one time your salary.

Me too and at that point, it absolutely makes sense to use up every possible year of the term while using the difference to contribute to pensions etc

Ultimately my point is both interest rate and term length are significant in reducing the cost of a mortgage, particularly in the early years. A 35 year term exposes the consumer to more risk of interest rate increases and property value decreases if they do not have the capacity to overpay the mortgage. A FTB who fixes for 5 years could come out at higher variables and a worse LTV meaning they do not satisfy the terms of the next fixed product then intended to switch to.

 

[NoRegretsCoyote]

f you can not afford the 25 year payment, that should be a red flag that you are over borrowing

This completely depends on your age. On average your income peaks in your late 40s. A 30 year mortgage for someone in their early 30s is perfectly fine. They have more than 30 years to repay it and, most likely, their income will rise over time.

there are no rules to protect consumers other than it must be ends at 65,

What other rules would you suggest?

the cost of a mortgage,

This is not a very meaningful term as BB has said. Money has a time value and an opportunity cost.

A 35 year term exposes the consumer to more risk of interest rate increases

Also to falls in rates. So a longer term could work out better.

 

[Brendan Burgess]

This completely depends on your age. On average your income peaks in your late 40s. A 30 year mortgage for someone in their early 30s is perfectly fine.

This is a very valid point.

In fact, there is absolutely nothing wrong with a 30 year old taking out a mortgage for their home which is interest only for 10 years. They should be repaying the capital when they are earning the most.

Brendan

 

[NoRegretsCoyote]

there are no rules to protect consumers other than it must be ends at 65, i.e you can only get a 35 year term at 30 yrs of age

Likewise this a poor rule. Take a couple who are divorcing at age 60 with €100k salaries and healthy pension pots.

They both need to borrow €150k to set up a house each. A 10-year mortgage each at 2.5% is about €1400 which would be feasible for each.

A rule to limit their mortgage to five years doesn't make sense here.

 

[DublinHead54]

I also consider my cashflow needs in the present. At the minute I am saving for a house deposit, so I need a larger monthly cashflow thus I want to minimize my monthly mortgage cost. I am coming up to the end of a 2 yr fixed (30 yr mortgage), I will probably fix for 2 years but ask for the term to be kept at 30 years.

My working assumption is that my cashflow needs should decrease in the future and then I will divert towards overpaying mortgage / decreasing term.

 

[Brendan Burgess]

At the minute I am saving for a house deposit, so I need a larger monthly cashflow thus I want to minimize my monthly mortgage cost. I am coming up to the end of a 2 yr fixed

Not sure that this makes a lot of sense? Do you want to provide the figures e.g.

Value of current house
Mortgage outstanding
Amount of savings
Lender

Target price of house you want to trade up to.

Brendan

 

[_OkGo_]

In general I agree with the majority the comments and I know that 'total cost' is not the best way of looking at it but for someone who does not understand the math, it is the only way to visually show that the term matters. However, the one assumption that seems to be made is that everyone is in a healthy financial position with high incomes. The advice should be very different to the average consumer.

Like many on AAM, I am comfortable that we can both accelerate our mortgage payments and contribute to our pensions. In the event of any temporary change in circumstances, we can easily return to minimum monthly payments on the longer term and pause pension contributions giving us a financial buffer. But my initial comments are more focused towards the average consumer on average industrial wage who can over extend themselves without realizing it. I (and friends) have received 'advise' from brokers and mortgage advisors such as:

• Go with 35 years, sure you'll have a wedding to pay for
• you might want to buy a new cars
• you'll eventually have to pay for childcare
• you won't feel it til they are in Uni

If the average consumers listens to this, spends the 'savings' on lifestyle instead of pensions (or other), they will end up with a house but very likely a small pension

In fact, there is absolutely nothing wrong with a 30 year old taking out a mortgage for their home which is interest only for 10 years. They should be repaying the capital when they are earning the most.

I disagree with this, that is a very high risk strategy even for a high earner. Unless you can guarantee that money is getting better value for you elsewhere then it does not make sense. Loading a pension in your 30's is not the answer. That money is locked away, never to be seen until retirement. And at the end of the 10 years, it leaves you wide open to market conditions
It also does not allow for the PV/FV as you have previously mentioned. If you purchased at 400k and had to sell the property in 10 years, it would need to sell at 440-460k to allow for inflation (1-1.5%) and get your cash equivalent back

Likewise this a poor rule. Take a couple who are divorcing at age 60 with €100k salaries and healthy pension pots.

They both need to borrow €150k to set up a house each. A 10-year mortgage each at 2.5% is about €1400 which would be feasible for each.

A rule to limit their mortgage to five years doesn't make sense here

I agree and in these situations, it is very different judging a wealthy 60 year old vs a 30 year old so banks should have scope to deviate here. But my understanding, and I'm open to correction here, is that mortgage protection policies are a big factor here. You are much more likely to die during the new term so you will not get insurance and therefore the bank is not protected in the event of your death.

 

[DublinHead54]

Not sure that this makes a lot of sense? Do you want to provide the figures e.g.

Value of current house
Mortgage outstanding
Amount of savings
Lender

Target price of house you want to trade up to.

Brendan

My 2yr fixed at 2.6% (420k outstanding) ends in April 2021, I was up until summer overpaying mortgage by 500 euro a month. I wasn't planning on a house purchase until late 2021 / early 2022 but things have change. I need around 150k deposit, and have a shortfall of 50k, so in the short-term I need to be maximising my cash savings hence I stopped overpaying mortgage. I have already made the decision due to personal circumstance to not sell my current property before moving.

I guess I did what you are a proponent of, I secured a lower mortgage repayment with the plan to overpay but keep the flexibility to reduce payments if needed.

 

[ashambles]

In general I agree with the majority the comments and I know that 'total cost' is not the best way of looking at it but for someone who does not understand the math, it is the only way to visually show that the term matters. However, the one assumption that seems to be made is that everyone is in a healthy financial position with high incomes. The advice should be very different to the average consumer.

Like many on AAM, I am comfortable that we can both accelerate our mortgage payments and contribute to our pensions. In the event of any temporary change in circumstances, we can easily return to minimum monthly payments on the longer term and pause pension contributions giving us a financial buffer. But my initial comments are more focused towards the average consumer on average industrial wage who can over extend themselves without realizing it. I (and friends) have received 'advise' from brokers and mortgage advisors such as:

• Go with 35 years, sure you'll have a wedding to pay for
• you might want to buy a new cars
• you'll eventually have to pay for childcare
• you won't feel it til they are in Uni

If the average consumers listens to this, spends the 'savings' on lifestyle instead of pensions (or other), they will end up with a house but very likely a small pension



I disagree with this, that is a very high risk strategy even for a high earner. Unless you can guarantee that money is getting better value for you elsewhere then it does not make sense. Loading a pension in your 30's is not the answer. That money is locked away, never to be seen until retirement. And at the end of the 10 years, it leaves you wide open to market conditions
It also does not allow for the PV/FV as you have previously mentioned. If you purchased at 400k and had to sell the property in 10 years, it would need to sell at 440-460k to allow for inflation (1-1.5%) and get your cash equivalent back



I agree and in these situations, it is very different judging a wealthy 60 year old vs a 30 year old so banks should have scope to deviate here. But my understanding, and I'm open to correction here, is that mortgage protection policies are a big factor here. You are much more likely to die during the new term so you will not get insurance and therefore the bank is not protected in the event of your death.

 

[Brendan Burgess]

I have already made the decision due to personal circumstance to not sell my current property before moving.

OK. Now it makes sense. I had assumed you were trading up and selling your existing property.

Brendan