The 100 year mortgage?

The 100 year mortgage?

Mortgage forms. Original image at http://img2.timeinc.net/toh/i/a/lower-mortgages-00.jpg

Who knows?

Among the recent mutterings about where the real estate business is headed is a thought about house prices doubling in the next twenty years. This thinking reflects a CIBC report published last year that led to a flurry of comments in various real estate forums and blogs (how I hate that word!), most of them agreeing with the inevitability of the author's observations.

Beyond it, however, there've been some concerns about the consequent decrease in housing affordability, and these have resulted in some talk of (gulp) 100 year mortgages.

Is such a possibility likely? Will lending institutions start to offer them? Will buyers show interest in applying for them? Will people ever end up actually owning their homes?

Fair questions all, but I'm not inclined to view them as being as farfetched as they may seem.

Lessons from the past

The CIBC report used the pattern of the preceding twenty years to support the view that prices will continue to rise. There may be a few hiccups along the way -- although this isn't considered altogether certain -- but, if it costs more today to buy a house than it did yesterday, so you'll undoubtedly pay more to buy one tomorrow. The real estate market may have its ups and down, but over any two decades the pattern is now a steady increase in prices.

In terms of affordability, though, this upswing isn't matched with correspondingly bigger paychecks. For some time, all efforts by the unions (who are in a stronger bargaining position than most employee groups) have had to focus on job security rather than holding out for a hike in wages. Keeping hold of what their members are already earning has been a tussle in itself, given the competition of products that can be produced at significantly lower hourly rates overseas.

Worse still, however, prices and affordability have moved in opposite directions. What used to be a comfortable ratio between an average annual income and the outlay for a house has widened year after year. Whereas in the 1950s and 1960s it took no more than a year's wages to buy a house, a family bringing in say $60,000 will now have to spend three, four, or five times as much to call the roof over their heads their own. Moreover, if the $300,000 home today is going to eventually go on the market for $600,000, the chances of wage and salary levels doubling in the same period of time has to be seen as being highly improbable.

Economic upheavals

What were known as 25 year mortgages were once the norm. It would take this length of time to make all the payments, but they would remain the same from start to finish.

However, this all changed as we went through what Trudeau referred to as The Revolution of Rising Expectations, followed by what I'm (not the only one) given to calling The Mulroney Error.

Through the 1960s and 1970s, annual pay increases were both expected and granted. You had only to stay in a job to become steadily better off. Prices went up, too, and they weren't by any means confined to houses. But the outcome was what the economists described as inflation: too much money chasing too few goods.

Perhaps not too surprisingly, some people felt that it was too much of a good thing and not only couldn't but really shouldn't last. This growing concern about an overheated economy led to a political determination to put an end to the wage/price spiral. It was heralded in Canada by Brian Mulroney in the mid 1980s, but his policies were no different than those of Margaret Thatcher and Ronald Reagan. All too suddenly maybe, pay raises stopped happening and the odds of actually staying in a job started to be in some doubt.

In a way, things were, in effect, brought back to normal, even if it sort of took half a lifetime and included some heartache for many people.

A couple of answers

One of the instruments for combatting inflation was interest rates and, for a time, these ran into double digits. Even if house sales and price increases were stalled, the cost of a mortgage on one rose dramatically. Thus, given that salaries and wages stopped climbing, the housing market went through some doldrums as affordability became a decided issue. Indeed, some households were faced with negative equity and started to turn their keys into the local bank. It didn't do their credit rating much good, but it seemed the only practical alternative to paying more for a house every month than it was worth.

In any case, though, during the 1990s the economy began to settle down and, ever since, fiscal authorities have continued to use interest rates to keep it from getting out of hand again. Fortunately, this approach included efforts to prime what eventually became a stalled economy -- which led to a progressive reduction in interest rates to what they'd been before the battle against inflation began.

We should be so lucky!

However, house prices soon resumed an upward climb and, as the CIBC report maintained, it doesn't seem likely to end any time soon.

Interestingly, this might have signalled a return to high interest rates, but this didn't happen. Instead, the banks changed the settings of mortgages. The difference didn't lie in the traditional 25 year amortization period; it would still take this long to make all the payments. Rather, interests rates ran for shorter periods and varied if the mortgage was open or closed. Subsequently the balance of the principal was rewritten at what was then a new interest rate, which might or might not be a more favourable figure. The underlying thinking was to keep pace with affordability. Although the cost of a house and the amount of mortgage payments were likely to keep rising, they could be offset by a borrower's ability to adjust the payments every few years.

It wasn't a perfect system perhaps and, if it meant a rise in payments to an unbearable level, it could lead to the heartaches that occurred when inflation was wrestled to the ground.

(This, in fact, is a key factor in the subprime crisis in the US. The overly liberal initial mortgage terms (e.g. "nothing down and pay what you can afford") have been followed by more realistic figures that too many people have been unable to handle.)

Longer terms and lower payments

Even so, along with shorter payment periods, the lending institutions then started to extend the amortization period. The total amount of principal and interest paid to the lender would be higher, but the monthly payment could become more managable if it was stretched out over more than the customary 25 years. Thus, 30 or 40 year mortgages surfaced and, while they've yet to prove all that attractive to the general public, they are certainly now available.

It's another answer to the challenge of affordability -- and, of course, could lead to the introduction of 100 year mortgages if house prices continue to double every two decades or so.

Just think of someone who can cope with buying an $800,000 home that's going to have a price tag of $1,600,000 in due time. As I've already suggested, a then buyer's income isn't expected to have become twice what it is today, is it? How then can mortgage payments be handled except by amortizing the cost over a period that's at least double the present 25 year norm?\

Maybe 100 year mortgages won't emerge until some long time in the future, but I think that 50 year ones can be seen as a distict possibility.

Or, as one blog commentator remarked, people are going to end up paying rent all their lives EXCEPT that it will be to the bank. Extreme though the thought may be, house buyers will have the benefit of having something to show for it at the end: an accumulated value in their home as opposed to nothing if the money has simply gone to a regular landlord.

In any case, this recognition is likely to keep the real estate business going regardless of where house prices and mortgages go.

Again, we should be so lucky, eh?!!