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Time to Go Long?

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Posted On: 12/24/2008

Q: Given the tremendous tumble in stocks and real estate, is now the time to get a longer loan, say 40 years or 50 years? With such loans you have smaller monthly payments that would make it easier to buy a home right now when prices are low.

A: Imagine that you have a $200,000 mortgage at 6-percent interest. The mortgage has a fixed rate and over 30 years the required monthly payment would be $1,199.10. Stretch the term to 40 years and the required monthly payment would be $1,100.43. Go for 50 years, if you can find such a loan, and the monthly payment would fall to $1,052.81.

The pattern is clear: For fixed-rate loans required monthly payments drop as mortgage terms get longer.

That said, there are several other issues to consider:

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First, the monthly savings that appear with longer fixed-rate loans are not assured with adjustable-rate mortgages. With ARMs, higher rates can mean higher monthly costs, so the advantages of a longer loan term can be easily lost.

Another problem with ARMs and longer-terms concerns “re-casting.” The worst example goes like this: Someone has an option ARM. During the start period the borrower can make monthly payments so low that even the interest bill is not being fully repaid. The unpaid paid interest is added to the loan balance. When the loan balance reaches 110 percent of the original debt the loan must then be re-cast – that means the monthly payment is changed so that the mortgage can be repaid over the remaining loan term.

If a borrower makes only the minimum required payment and the option ARM has a 40-year term then some option ARMs can be re-cast in 28 months according to a September 2008 study released by Fitch Ratings. Substantially higher monthly costs mean more delinquencies and foreclosures, results neither borrower nor lender should want.

Second, longer mortgages have steeper potential interest costs. For the 30-year loan above the total interest bill if the loan remains outstanding for its full term would be $231,676. At 40 years a borrower would have paid $328,206 while over 50 years the interest cost would come to $431,686.

Third, the “potential” interest cost is not a real concern. Why? Because few borrowers will hold a loan for 30 years – and fewer still for 40 years or 50 years. What’s not irrelevant is this: The longer the loan term the slower the rate of amortization with a fixed-rate loan. This means with a longer loan the lender gets a bigger check at closing when a property is sold or refinanced before the end of the loan term.

For example, after 10 years the borrower with a 30-year loan owes $167,371.60, the property owner with 40-year financing would owe $183,541.67, and the borrower with 50-year financing would have a remaining loan balance of $191,345.54.

If qualifying for a mortgage is a concern, then consider a longer-term, fixed-rate loan which allows prepayments in whole or in part at any time and without penalty. Why? Because the lower monthly cost will make qualification easier and as your income improves you can increase your monthly payment – thereby cutting the loan term, reducing the debt more quickly and saving potential interest costs. Speak with lenders for specifics.

Q: We have lived together in our house for over 30 years but never married. We have two children, we both have contributed financially toward home improvements and mortgage payments. The house is in his name only. What needs to be done to assure that if he dies before me the property will belong to me?

A: Let’s be pragmatic. Society encourages marriage through tax benefits, protections against liability and in many other ways. After 30 years, get married. Then have title to the property changed by an attorney to include you both as a “tenancy by the entireties,” a form of ownership reserved for married couples that means you both have a 100-percent interest in the property. Should one of you die the other remains the owner of the property – there is nothing to inherit (or tax) because you already own the house. Such an addition to the title is allowed under the Garn-St. Germain Act. It says a lender cannot call a loan if there has been “a transfer where the spouse or children of the borrower become an owner of the property.”

While you’re with the attorney get the rest of your paperwork in order. You each need a will and a living will.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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