Topic: Capitalism
Mortgage Anyone? Why are the standard terms for mortgages 15 and 30 years? Could it be because downturns in the American economy have occurred on an average of once every 14.5 years? When a buyer defaults on a loan after paying on it for 14 years, the lender gets the house for free, sells it again, and nets a small fortune or an investment of zero. Wouldn't you like to find a way of doing that?by John Kozy
(centrist liberal libertarian)
Wednesday, September 30, 2009
Have you ever wondered why the standard terms for mortgages are 15 and 30 years rather than 10 and 20 or 25 and 50? I have, but was never able to find a satisfactory answer. Then I discovered something interesting. Since this country was founded, downturns in the economy have occurred on an average of once every 14.5 years. This similarity may, of course, be sheer coincidence. But I'm suspicious.
Why?
Well, if you amortize a standard 30 year mortgage at six percent interest, you'll discover that the lender gets all of the money it has invested back in 13 years and 11 months.
Now look at what happens to a home buyer who takes out a mortgage just after an economic downturn, pays on it for 14 years, a downturn strikes, and then for whatever reason cannot sell his home and defaults. The lender gets the house and the buyer has lost all the money he/she has put into it.
But look at what happens to the lender. It has already gotten its initial investment back, so in reality it loses nothing. But now it has a house to sell. How much has the lender paid for this house? Nothing! So it sells the house to another buyer by providing another mortgage. Now if the initial buyer had continued to pay the loan to term, the lender would have earned about as much as the initial investment. But now everything the second buyer pays is pure profit, not just the computed interest. In reality, the total amount of the mortgage loan is earned interest on an investment of zero. Wouldn't you like to find a way of doing that?
Of course, such situations don't come about often. Although the average time between economic downturns is 14.5 years, downturns happen at varied intervals. And even in downturns, many people forced to sell their homes usually can. But it doesn't take many who can't to make lenders a lot of money. Just five people forced into the situation described with $100,000 loans would net a lender a hefty one million free dollars. If the loans are larger, the lender nets even more. And, of course, the numbers are different for different interest rates. But the principle is the same. Lenders almost always get their initial investments back in half a loan's term or less.
The views expressed in this
article are those of John Kozy only and do not represent
the views of Nolan Chart, LLC or its affiliates. John Kozy is
solely responsible for the contents of this article and is not an
employee or otherwise affiliated with Nolan Chart, LLC in his/her role as a columnist.
Posted By: Walt Thiessen
Date: 2009-10-02 08:11:05
Well, to be fair, your claims are a bit exaggerated. I grant that a home foreclosed and seized after 14 years of mortgage payments is quite profitable for a lender. However, you neglect to mention that the overwhelming (and I do mean overwhelming) majority of homes seized at foreclosure have had their mortgages paid for a lot less than 14 years. Nearly all the homes foreclosed as a result of the current crisis were originally mortgaged less than 10 years ago, and the great majority were mortgaged less than 5 years ago. People who manage to make their mortgage payments for at least 14 years rarely have trouble selling to get out from under the mortgage, because even after the recent large declines in home prices, they can still sell their homes (in most cases) for more than what they originally paid. So, they don't get foreclosed.
The people having the problems these days are mostly people who financed to buy during the real estate boom from 2001 onward. These people have not paid back the equivalent of the original loan amount.
Further, in most cases, when a house is foreclosed, it often gets abandoned in poor condition. This means that the forecloser has to invest more money to make it saleable.
So it's really not accurate to say that the lender generally makes a killing. In fact, in a large number of cases, the lender ends up losing lots of money.
Umm... You'd have to have loans and foreclosures MASS cycling every 14.5 years to match up to those downturns to prove the trend that you are trying to link.
A quirky coincidence in the 15/30 mortage and the downturns, but it's quite a bit of leap to connect.
There seems to be a glaring lack of understanding of what we Economists call "Opportunity Cost" here. The notion that banks loses 'nothing' is absurd.
When the bank issues a mortgage, it is paying out the FULL amount of that mortgage to the seller. For the 14 years or so it holds the mortgage, it no longer has those funds to invest. It has given up all of the investing it *could* do during those hypothetical 14 years with the funds it paid out.
The bank does that because it expects to make money on the mortgage it makes. When that doesnt happen and it forecloses, this is not all free, found money: the money belongs to the depositors of the bank who put the money there in the first place.
Yes, the bank may make a profit on the appreciated value of the house over and above the mortgage amount, but this is usually LESS than the amount of interest they would have colleceted if the note went to term, and therfore, a poor investment when other alternatives are considered.
Want to comment on this
article? Leave your comment here. Your email address is
required to track your comment. However, we will neither
publish your email address nor distribute it to other
organizations or persons. The only reason we might use
it would be if we needed to contact you regarding your
comment. All comments are subject to our
terms of use policy.
