Is a 40-year mortgage bad for your wealth?
Growing numbers of would-be buyers are pushing the problem of affordability into the distant future. Kate Hughes asks if they are simply storing up even bigger issues
So you want to buy a home. You want to know you will have the same roof over your head for longer than the next two months. You want to know your kids are settled at school or that it’s worth investing in that season ticket for your commute.
You might even want to paint the walls in your own home without having to ask for permission first. You want stability, to pay off your own mortgage rather than someone else’s, and to save a huge chunk of money over the long term by buying rather than renting.
With mortgage repayments typically being significantly lower than renting the equivalent property in most parts of the country, some studies suggest the difference in monthly bills alone could be hundreds of thousands of pounds over an adult life.
That’s before you even take into account the asset held – or not – in the end.
And now, with the property market wavering, especially in the South, there may just be a chink of light on the home ownership horizon.
There’s only one problem: affordability. Or, more specifically, the affordability criteria lenders use to decide if you’re a good bet for the money or not.
It has been 10 years since the financial crisis prompted the tightening of lending rules that included things like the ban on self-certified mortgages, and tougher restrictions around affordable lending.
These days, rather than focus on what you earn, lenders will go through your income and outgoings with a fine-tooth comb to determine your creditworthiness.
Meanwhile, property prices in many, though by no means all UK regions, have continued to rise while real wage growth has only recently slipped back into the black.
The result for millions of would-be buyers is that the numbers just don’t stack up, especially when it comes to paying the loan back over the standard 25-year term.
But home loans don’t have to be standard. The longer you take to pay it back, the lower the monthly costs and the corresponding affordability thresholds. Forty year mortgages have been around for a while, but the appetite for them is now growing rapidly.
Half of home buyers would consider a 40-year mortgage in a bid to keep their monthly repayments affordable and get onto the property ladder sooner, according to data from Santander Mortgages, which calculates that extending the term by 15 years could mean the average monthly repayment falls by more than £260.
In fact, it claims that pitching for a 40-year deal, rather than a 25-year term, could help 3.25 million more first-time buyers get onto the property ladder.
Short and sharp
While that solves the immediate problem, the longer the loan, the longer the interest charges have to mount up.
Take out a 25-year term mortgage for a total of £150,000 at 2.5 per cent, and your monthly repayments will be somewhere around the £795 mark. Extend the term to 30 years and the monthly costs drop to around £593. Add another 10 years to round your term up to 40 years, and you’ll only pay about £495 in repayments every month.
Extending the loan from 25 to 40 years, though, means your total interest payments over the life of the mortgage more than double from £40,700 to £87,400 on an original loan of only £150,000, according to number crunching by independent mortgage broker L&C Mortgages.
“The rule of thumb is to keep the mortgage term as short as possible, as it will help keep the overall cost of the mortgage down,” warns David Hollingworth, a director at L&C Mortgages.
“However, it’s understandable that borrowers, especially first-time buyers, will be keen to give themselves some breathing space when they first take out their mortgage.
“That doesn’t mean that they can’t keep that position under review. Once they come to remortgage at the end of the current deal, there is absolutely nothing to stop them restructuring the mortgage onto a shorter term.
“That may be helped by a change in their circumstances such as rising income. Even during the initial deal they can consider making overpayments as and when they can.
“Most lenders will allow some level of overpayments to be made without incurring a penalty, typically up to 10 per cent every year, even during a fixed rate period.”
But the pay-off between easier-to-manage-payments now and bigger bills longer-term is only part of the equation.
With a typical deposit on a first home now coming in at almost £31,000, according to Experian, first-time buyers aren’t getting a foot on the ladder until they reach 33, government figures for England suggest. That makes them 73 before they finally own their home outright.
Is it worth it?
One in five Britons is already retiring with outstanding debts of almost £34,000, according to historical data from Prudential. And that’s before the popularity of longer mortgages to cover the cost of homes that are otherwise unaffordable filters its way through.
Should future generations be bracing themselves to inherit their parents’ significant debts rather than the family home?
The figures suggest a crisis in the making, fuelled by a widespread bid to get onto the housing ladder at almost any cost – to make life fit the loan rather than the other way around. It seems the opposite of what those lending criteria changes were designed to do.
So are we at risk of ruling out a modern solution because our attitudes towards life, work and income are out of date?
“Although taking a longer-term could see homeowners have debt for longer, lenders will ask questions around extending the life of the mortgage into retirement to ensure it will remain affordable, especially for those getting closer to retirement age,” adds Hollingworth.
“Again the ideal is that borrowers target repaying the mortgage by retirement, especially as they are likely to see a reduction in income post retirement which will be impacted further by mortgage payments. As more of us live and work for longer, those time frames may shift though and there’s certainly a growing range of options for older borrowers as well.”