The National Post ran this story today: 40 Years of Debt. Here are some highlights, emphasis mine:
Benjamin Tal, a senior economist with CIBC World Markets, says the change in the way Canadians pay off their mortgage is the most significant innovation to hit the industry in almost three decades.Want to know how much that 40 year amortization "saves" you every month? I'll do up the numbers on an arbitrary $300,000 mortgage. Doesn't matter what you put down or what your home is worth, the mortgage is $300K regardless. Interest rate is 5.85%.
Mr. Tal, who is the process of compiling a report on how the new products have changed the market, says interest-only and zero-equity loans are probably less than 1% of new business. It's the long-term amortization that has caught everybody's fancy.
"They were available in the early '80s and nobody was interested. The attitude toward debt is totally different now," says Mr. Tal, who adds his study will show a "significant" amount of new money is geared toward that 2047 mortgage-burning party.
The Canadian Real Estate Association says the average sale price of a home was $311,495 in July. If you bought that house with 0% down and a 25-year amortization, the total interest would end up being $277,993 over 25 years, based on monthly payments and an interest rate of 5.85%, a typical discounted rate today. Extend the amortization period 40 years under the same terms and you end up paying $488,116 in interest --more than the price of the house.
[Mr. Cirotto, www.amortization.com] laughs at the suggestion the 40-year amortization is giving Canadians more flexibility when it comes to making lower monthly payments. "I'm not sure you can call it an advantage to pay interest for another 15 years," says Mr. Cirotto. "To me it's bullshit. The best way to save money is not to have any mortgage."
Much of what is happening in Canada has been lender-driven, agree many in the industry.
"The 40-year amortization is the only way to get people qualified."
$300K over 25 years = $1892/month and $267,732 in interest
$300K over 30 years = $1756/month ($136 lower than above) and $332,188 in interest
$300K over 35 years = $1666/month ($90 lower than above) and $399,754 in interest
$300K over 40 years = $1604/month ($62 lower than above) and $470,112 in interest
So by amortizing over 40 years you'd "save" yourself $288 dollars a month. In order to save yourself $288 dollars a month it will cost you $202,380.
Look at those numbers again. Notice how the big jump in monthly payment "savings" is between 25 and 30 years? Every five year period tacks an additional $70K in interest, roughly. But the payment doesn't lower proportionately. In fact, the "savings" shrink drastically the longer you amortize. There are some even more interesting numbers at work here behind the scenes. They have to do with income.
If you want to amortize $300,000 you need a household income of approximately $83,000 annually--that's assuming 0% down and no other household debt. What happens when you amortize over 30 years? Income need drops to $77,500. Over 35 years? $74,000. Over 40 years? $72,000.
Rather than close with my own advice for you, I'll quote someone far more knowledgeable than I:
[Mr. Cirotto] has an answer for the people who say the only way they can buy a house is with a 40-year amortization: Don't buy a house! "There a lot of people buying a house who shouldn't be buying the house they're buying. They need to buy a smaller house. People turn down their nose at smaller houses. They need to lower their expectations."I know this article is leading, but I believe that readers of this here blog are smart enough to see through my opinion and form their own. So I give you another poll. Comments, as always, are welcome.