A few days ago, we finally completed our staircasing and we now own 100% of our (previously shared-ownership) apartment*. As part of the process, we had to get a new (larger) mortgage and… surprise surprise… I did some research. While researching, I was shocked to learn that the UK government was considering approving 50-year mortgages!
Don’t believe me? read for yourself:
Government considering 50-year mortgages that could pass down generations to tackle housing crisis | UK News | Sky News
“But what’s wrong with 50-year mortgages? Won’t it help people get on the property ladder? Won’t it help with housing affordability?” they asked without diving into numbers.
Have no fear, Lazy FI dad is here (can we get this as a bumper sticker?). I will dive into the numbers for you.
50-year mortgages as a solution for housing affordability
Before the number-heavy part of this post, let’s start with the obvious. If the affordability issue is due to high property prices (the most common claim), the goal should be to reduce property prices. Offering more people a ridiculously long-term loan will increase the demand and as any first-year economics student knows, an increase in demand will usually result in a price increase.
However, that’s not my biggest issue with this idea. I have a problem with the maths behind the 50-year mortgage idea. Increasing the duration of a mortgage from 30 to 50 years is just not worth it (assuming you don’t fix the interest rate for the entire 50 years)- time to dive into the numbers. I’ll run you through an example and then you can use the embedded Excel calculator I created to run your own scenario.
50-year mortgages don’t make sense mathematically
Meet Lazy FI Couple. They want to buy a £400,000 property and they have 15% as a downpayment. This means they will borrow £340,000 (400,000*85%). The annual interest rate is 4%. Using some assumptions that can be seen in the Excel model**:
If they take a 30-year mortgage they will pay £1,609.23 a month.
If they take a 50-year mortgage they will pay £1,295.34 a month.
The 30-year mortgage payment is 24.22% higher. However, the 50-year mortgage is 66.67% longer!
How is that a good deal? It actually gets worse the longer the term (length) is.
If you take a 100-year mortgage, the monthly payment would be £1,135.56. If that seems awfully close to the payment in the 50-year mortgage, that is not a coincidence.
The reason for that is the structure of loan repayments. Let’s ignore the 100-year mortgage for a moment and focus on the 30-year mortgage vs the 50-year mortgage.
Loan repayment structure
The first month of a 30-year mortgage
The best way to look at this is to focus on the first payment (one month after taking out the mortgage). In our example, we have a £340,000 loan with a 4% annual rate, which translates to a monthly rate of 0.327% (rounded). If you’re wondering how I got to this number, please the notes at the end of the post.
That means that you started with a loan balance of £340,000 and it accrued interest of £1,113.07 (roughly 0.327%*340,000 but I didn’t round it, £1.113.07 is the accurate number). That means that the first £1,113.07 goes to cover the interest. Only the difference between the £1,113.07 and the actual monthly payment goes to reduce the mortgage amount (the “principal”).
In our example, the 30-year mortgage has a monthly payment of £1,609.23. At the end of the first month, that payment covers the £1,113.07 of interest and reduces another (1,609.23-1,113.07) £496.16 from the mortgage principal.
The first month of a 50-year mortgage
The 50-year mortgage has a monthly payment of £1,295.34. At the end of the first month, that payment covers the £1,113.07 of interest and reduces another (1,295.34-1,113.07) £182.36 from the mortgage principal.
You can see that it’s not the total payment in the first month that counts. It’s only the amount above the monthly interest (£1,113.07). The 30-year-mortgage monthly payment reduces the loan by £496.16 compared to £182.36 for the 50-year mortgage. That’s almost triple!
It gets better. The following month, the 30-year mortgage interest will be lower, let me explain. The 30-year mortgage cleared £496.16 in month 1 and now has a balance of £339,503.84. The 50-year mortgage was reduced by £182.36 in month 1 and now has a balance of £339,817.73.
Not only does the higher monthly payment get rid of the mortgage quicker, but the interest amount is also smaller as well! That’s because both scenarios used the same rate but the 30-year mortgage multiplies that rate by a lower balance.
Try it yourself
Before you try, a few disclaimers:
This calculator is my own calculation. I’m human and may make mistakes. If you are about to take out a mortgage, please check the monthly payment in your contract and DO NOT rely on the numbers in this calculator. In any case, it won’t agree to the penny due to the assumptions (see “Notes” section at the bottom of this post).
Instructions:
As usual, edit the yellow cells and give it a couple of seconds to refresh. If you’re on your mobile phone, double-click/tap a cell to edit it. Enjoy!
The sweet spot
Based on my analysis above, you would assume I prefer the shortest possible mortgage terms. That’s not exactly true. If we go back to the 30/50/100-year examples, the monthly payments are:
30-year mortgage: £1,609.23
50-year mortgage: £1,295.34
100-year mortgage: £1,135.56
I’m sure you noticed that the decrease from 30 years to 50 is much larger than the decrease from 50 years to 100. Now you understand why. It’s because it’s only the amount over £1,113.07 (in the first month) that actually reduces the mortgage amount.
This means that the shorter the term is initially, the more you save/reduce your monthly repayment. 30 years is long enough (in my opinion), but increasing it to 50 years doesn’t have that much of a benefit. The saving of £313.89 a month is not worth, in my opinion, paying that amount for 20 extra years and almost doubling the length of my mortgage.
However, increasing the length from 10 to 20 years, for example, has a huge effect and will reduce your monthly payment dramatically***.
It’s all about finding the sweet spot by playing with the numbers. I’m sure (or at least hope) that most people would be motivated enough by shortening their mortgage by 20(!!!) years to find an extra £313.89 a month. However, for some people, £313.89 a month could be the difference between being able to afford the repayment or not.
First of all, if that is the case, you’re cutting it a bit close, an increase in expenses or interest rate could cause a lot of trouble for you, always leave some buffer.
Secondly, let’s say £313.89 is a huge difference and an amount you just can’t save (extra a month). If that’s the case, at least go to 40 years. The monthly payment would be £1405.91, £110.56 lower than the 50-year mortgage monthly payment.
£110.56 extra a month to shave off 10 years of mortgage payments has to be motivating enough for you to find an additional £110.56 somewhere.
Fixed interest rate
The analysis above assumed that you use a variable rate or a short-term (up to 5 years) fixed rate.
If, however, the 50-year mortgages had a fixed rate (as suggested here) for the entire 50 years, that’s a whole different story. If the interest rate was tempting enough, I would probably take it.
Security
Most mortgages in the UK have a fixed term of up to 5 years. After 5 years (or less), you would usually remortgage and fix the rate for another few years and so on until the mortgage is paid off.
That gives you the security that your monthly payment won’t increase in the next (up to) 5 years.
Inflation
However, when you renew it- it can increase (or decrease) dramatically. Fixing the term for 50 years gives you the security of knowing your exact monthly payment for the next 50 years. Not only that, inflation works like compound interest in the sense that it becomes more powerful as time goes by. After 30,40, or even 50 years, that monthly payment in real (inflation-adjusted) terms, will be so much smaller! If that’s confusing, let me try and clarify.
Let’s say you are an employee and your employer “only” increases your salary to keep up with inflation each year. Every year your salary increases but your mortgage payment stays the same for 50 years. The % of your salary that goes towards the mortgage gets smaller and smaller as time goes by.
Inheritance
Another issue with 50-year mortgages is that you are less likely to pay it off in your lifetime. That means that your kids (assuming they get your inheritance) will have to pay it off.
I must admit that doesn’t bother me that much because:
1. They can always sell the property, pay the mortgage off and (hopefully) have some money left.
2. Assuming the lower monthly payments went to savings, the inheritance will include a larger mortgage but also more savings. Although these don’t exactly net each other out, it’s still something to consider. It’s not just throwing a loan on your kids without other assets.
Summary
The longer the length of the mortgage is, the less benefit (decrease in monthly payment) you’ll get by increasing the length of the mortgage. Because of that, I think that 50 years is just not worth it. However, signing up for a mortgage where the interest rate is fixed for the entire 50 years has its own benefits and I would consider that. However, even in that scenario, I would probably prefer taking out a 30 (or less) year mortgage with a fixed rate for the entire length of the mortgage.
Just in case you were wondering, we did not take a 50-year mortgage 🙂
Notes
* I wrote about our initial purchase and shared ownership in general (including what “staircasing” means) in this post:
Buying a shared ownership property – Lazy Fi Dad
** The main assumptions are:
1. Payments are made at the end of the month.
2. The interest in each month is the same despite some months having more days than others.
3. The monthly interest rate is not just the annual rate divided by 12 but uses compound interest so the formula is: (1+annual rate)^(1/12)-1.
***In our scenario, the 10-year monthly payment would be £3,430.79 while the 20-year monthly payment would be £2047.54. You double the length of the mortgage but the monthly payment gets cut by almost half (59.68% if you insist).
