A Closer Look at 30 Year Mortgages
It is no surprise that the most common length of loan in the US is the 30 year mortgage. Is this just another example of Americans spending as much or more than they earn or is it something different? Borrowers are unaware of the substantial consequences of a 30 year mortgage. If it were explained to them the difference in equity position instead of simply lowering their payment at the time of loan application, I feel they would choose a shorter term loan.
30 Year Mortgage VS 15 Year Mortgage
After 5 years of paying on a 30 year mortgage of 150k at 6%, borrowers still owe 91 percent of the original loan amount. Another way to say it is that after paying on a loan one-sixth of the term, the borrower has only paid off 9% of their loan. Since the average homeowner moves every 4 years, the only way a borrower will ever gain significant equity is when property values rise. They would realize this gain in equity no matter how they purchased the home. With a 30 year mortgage, a borrower might be better off renting when you calculate the cost of repairs and closing costs involved with a loan. The trickle down effects of this one decision could drastically impact their financial situation. Consequently, the effects of a 15 year mortgage are very encouraging. After 5 years of the same loan above the loan balance is at 70 percent. That is 30% equity. The difference in payment is $366/mo. higher but the buyer has $45,000 in equity as opposed to $13,000 with the 30 year mortgage. With the 30 year mortgage, (if the home doesn’t appreciate in value) the seller could sell the home but after paying normal seller closing costs they might walk away with about $2k in their pocket (if the buyer doesn’t ask them to pay any of their closing costs of approximately $4500.) With the 15 year mortgage, the buyer would walk away with about $29,500 even if they pay the buyers closing costs of $4500. That is a profit of almost $30k simply by choosing a 15 year mortgage compared to a $2500 loss or at best a break even situation in the case of the 30 year mortgage.
Imagine if all Americans had significant equity as in the case of the 15 year mortgage, how better off we would all be. This would be an incredible boost to our enonomy because of the extra money homeowners would have after selling their first home. Sme would be spent on buying a bigger more expensive home and with that they need new furniture so they would spend additional money and it wouldn’t have to be on their credit cards. The only ones benefitting from the 30 year mortgage are the banks. They are fully aware that with a 30 year mortgage people just aren’t paying their houses off and that’s the way they like it. How do you think banks and mortgage companies got so big in the first place? After all, nobody is putting a gun to their heads to make them get a 30 mortgage. If we all changed the way we think about mortgages and forced ourselves to get 15 year mortgages, our entire country would have less debt. If you can’t afford the 15 year payment on a home, maybe you should buy a less expensive home. If it were explained to people what happens over time, I think many more would choose the wise option of a lower term loan. If we did, our government that owns most of our loans would have significantly less control over us. So what do you think, should 30 year loans be illegal?
Is owner finance preferred over traditional financing?
Filling the Void
Owner finance is filling a void that is needed in our housing market that could compensate for the lack of effectiveness where FHA and conventional loans are lacking.
Advantages of Owner Financing
An important component of our economy is the housing market and owner financing is a solution that allows more homeowners to be approved for a loan that otherwise would have to resort to being tenants. If structured correctly, like our program, owner financing creates an environment that FHA and conventional loans aspire to achieve.
Our program is structured so that the new owners gain equity faster than traditional loans because they are structured on a lower number of years (term) than most traditional loans. More equity for the homeowner means that they are less likely to give up on their home so easily as we have recently seen in our housing market with the large number of foreclosures. When people have “skin in the game” they are going to sacrifice other items in order to pay their house payment instead of jumping ship because they have nothing to lose.
Lower Closing Costs
Another important factor with owner financing is the fact that there are no closing costs or very few closing costs so the majority of the funds brought to the closing table go towards the loan balance as well creating even more equity.
How Financing Should Be Structured
The culture of owner finance, if structured correctly, is how financing should have been structured in the first place with 2 simple but extremely important fundamental requirements.
- People should not be allowed to purchase a home unless they are able to put down at least 8-10%. If they don’t have the money, they should save until they do. If they are incapable of saving that amount they should remain tenants until they are able to save money. Being a homeowner is at times expensive and you need to be in the habit of saving money in case something needs to be repaired. The practice of saving is a good habit to form for their future to prepare for a rainy day. We have people call us all the time that don’t have our required down payment but they like our homes so much and they tell us that they are going to start saving their money and call us back in a few months when they have the money….and many times they do exactly that. People just need something to shoot for and truth be known, they want to invest in their home. It feels good to them to accomplish paying down their house. It gives them pride and a sense of accomplishment. Someone who is proud of their home doesn’t give up their home without a fight.
- People should not be allowed to finance a loan for 30 years. The maximum term should be 20 years. If they can’t afford the payment then they should buy a less expensive house. What usually happens with traditional loans is that loan officers extend the term so they can squeeze their payment into an amount that allows them to have an acceptable payment ratio. This is done so that the underwriter will approve the loan because their payment is lower. If this is so important, why not finance a home 40 or 50 years? This may sound ridiculous but 30 years is almost just as bad…why not? A 30 year mortgage pays almost nothing towards the principal in the first 5 years and since most people move every 5 years or less, people usually don’t have any equity when they sell as a consequence. If lending institutions would follow these 2 common sense fundamental rules, there would be significantly fewer foreclosures and we would not have a housing crisis and there would be no need for government bailouts. Unfortunately, the lending institutions realize that when we as a population have significant equity it is bad for their business. The next thing you know lots of people would own their homes and there would not be a need for loans therefore, no repeat customers. Owner finance appears to be more popular every day because of the reasons above.