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Why Trump’s 50 Year Mortgage Scheme Is an Even Worse Idea Than You Imagined

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Your humble blogger does not like having to discuss lame proposals because giving them any attention has the effect of legitimating them. However, since the Trump 50 year mortgage proposal can’t be put back in the toothpaste tube, let us contribute to the chorus of well-warranted criticism by adding some issues that don’t yet seem to have been aired.

Let’s first turn to the obvious negatives. The Trump idea is an admission that he and pretty much everyone are unserious about addressing the housing unaffordability problem because too many powerful players benefit from it. The most obvious remedy is to build more middle/lower middle class residences in high cost areas. But right away, that runs hard into NIMBYism: all those well off with their tony houses don’t want the servant classes or even dull normals living nearby and possibly harming their property prices.

A confirmation of that notion: the last time I heard about 50 year mortgages was in the 1980s in Japan during its bubble years. To give an idea of how badly overpriced residential real estate was (along with the more famous commercial real estate bubble), I visited a prime 3 bedroom, where a bedroom was barely bigger than a tatami mat, with a gallery kitchen, one bath, and a small combined dining and living room, owned by a board member at Sumitomo Bank. It was about 900 square feet. The price in 1989 was $5 million, or in current dollars, $13.4 million.

A search on Japan’s 50 year mortgages reminded me:

As the bubble progressed, lender expectations improved, leading to excessively loose credit standards. New 100-year, three-generation mortgages popped up. Grandkids would be paying off their parent’s parent’s mortgage.

Another measure would be to reverse rules that made what were formerly called single-resident occupancy apartments illegal. My understanding is that what killed this type of cheap housing, which kept many from being homeless, was barring shared bathrooms. Funny how we are just fine with them in student dorms and military barracks….and homeless shelters.

We’ll turn to points many have already raised, that the 50 year mortgage would preserve and promote unaffordability by loading up borrowers with mortgages they could probably never pay off (assuming they never moved) and would saddle them with more interest over the loan life. So it’s another “help the FIRE sector at the expense of the citizenry” plan.

But the popular freely-refinancable (as in no prepayment penalty) 30 year fixed rate mortgage is a very unnatural product and is found in comparatively few advanced. economies. On paper, it puts the interest rate risk on the lender. If rates drop, borrowers refinance, taking the loan away from creditors just when taking the risk of longer-dated loans is paying off. There are many ways to better share the interest rate risk, such as barring refis for the first five to seven years of a mortgage, or having interest rates float subject to a floor and ceiling. I had that sort of product in the early 1980s and was very happy with it. You can pencil out what your worst-case mortgage costs might be and benefit with no expenditure of effort if interest rates fall.

So why is this supposedly borrower-favoring feature, of the “freely refinancable” fixed rate mortgage, actually not good for borrowers? Because that option is NOT free! Not only do borrowers pay fees when they refinanace, but lenders have succeeded in structuring refis so that roughly 2/3 of the economic benefit of the refi is captured by financiers, not by the homeowner.

A related bad feature of the refinancable 30 year mortgage is that it increases systemic risk. Mortgage guarantors Fannie and Freddie have to hedge the refi risk. That hedging is pro-cyclical on a systemically disrupting scale. From a 2012 post:1

Both Freddie and Fannie have a long standing practice of hedging their prepayment risk. Their hedging activities are so massive as to have macroeconomic impact. They are “pro cyclical” meaning they tend exaggerate interest rate moves, pushing them down faster when they are falling and forcing the higher when they are rising. Greenspan was concerned about the distortions caused by the GSE’s hedging in 2003 and was relieved when the Freddie and Fannie accounting scandals led to them having their loan growth restricted, since it kept a big problem from getting even bigger. John Dizard of the Financial Times discussed this problem in early 2008:

The core problem for the housing GSEs is, and has been, the prepayment option embedded in US fixed-rate mortgages. That has meant that the term of the GSE assets extends or contracts depending on whether homeowners can refinance at an advantageous rate. However, most of the long-term debt on the liability side of the GSE balance sheets has a fixed term. So the GSEs must more or less continually offset this imbalance between the average maturity of their assets and liabilities through the derivatives market, specifically the interest rate swap market. Otherwise the mark-to-market losses would overwhelm their small equity bases.

Recall that Greenspan advocated floating mortgages then too, again to try to reduce the needed level of interest rate hedging.

50 year mortgages will make both these problems more severe. 50 year mortgages, compared to a 30 year obligation have more of their payments over their life in interest. That means in a refi more total interest savings. That means even more in fee extraction by middlemen! More critically, it also means much greater pro-cyclical hedging action, and thus an even bigger increase in systemic risk, assuming that there actually was consumer receptivity to this bad idea.

Let us turn the microphone to others who have derided this Trump mortgage plan. From Michael Shedlock, who documentshow much more a borrower will wind up paying in interest:

The FHA head said the proposal is a “complete game changer.” Yeah right.

Complete Game Changer – Not

  • 50-Year mortgages won’t help with the down payment. For many, that is a huge obstacle.
  • Home prices are starting to decline. Anyone who needs to sell their home within a few years would be upside down. We don’t nee more people trapped in their homes.
  • Prices need to fall and fall dramatically. To the extent the product would create demand, it would help keep prices higher.
  • The average age of the first-time home buyer is over 30. Congrats. They would own their home at age 80+, assuming they were still alive. If not, heirs would own the mortgage.
  • 30-year mortgage rate are higher than 15-year rates. 50-year rates would be higher still. The higher rate would eat up some of the alleged “savings”.
  • People are already in trouble because they do not understand property taxes or maintenance……

Addendum

After 12 years of payments on a 50-year mortgage very little principle will have been paid back.

Here’s the exact comparison for a $400,000 loan at 6% fixed rate after exactly 12 years (144 monthly payments) on 15-year, 30-year, and 50-year mortgages.

And Supermoney in 5 Reasons Why Trump’s 50 Year Mortgage Proposal Is a Horrible Idea:

1. Little effect on affordability

With home prices and mortgage rates both high, a new idea is gaining traction—the 50-year mortgage….

How a 50-year mortgage works:
The longer term reduces monthly payments, helping buyers meet debt-to-income (DTI) ratios.

Illustrative example at the same 6.30% rate on a $500,000 loan:

  • 30-year loan: ~$3,103/month
  • 50-year loan: ~$2,801/month
  • Monthly savings if rates were identical: ~$302

Longer terms have higher interest rates

>Reality check: 50-year loans would carry higher rates (+0.7% to +1.0% or more) because they expose lenders to decades of extra risk. At a realistic 7.00%, the 50-year payment rises to ~$2,907, cutting savings to just $196/month. At 7.30%, savings shrink to $146/month.

2. Explodes the long-term cost

SCENARIO RATE MONTHLY PAYMENT TOTAL INTEREST
30-year standard 6.30% $3,103 $617,080
50-year — Same rate (unrealistic) 6.30% $2,801 $1,180,600
50-year — Realistic rate +0.70% 7.00% $2,907 $1,244,200
50-year — Conservative +1.00% 7.30% $2,957 $1,274,200

Bottom line: The longer term guarantees a higher rate. Once that penalty is added, the monthly “savings” become tiny, but the lifetime cost explodes past $600,000 extra interest.

3. Retirement risk

A borrower who buys a home in their early 30s could still be making payments well into their 80s….it blurs the line between owning and renting — you may technically own your home, but you’re still making payments for most of your life.

Entering retirement with a mortgage means a large, fixed expense at precisely the time income typically drops. …What seems like affordability in the short term could become a generational form of debt…

4. Will lead to housing inflation

Longer terms let buyers qualify for bigger loans, which pushes prices higher in supply-constrained markets. Canada (40-year loans pre-2008) and the UK (35–40-year terms) saw similar demand spikes followed by tighter rules. Extending terms doesn’t add homes, lower land costs, or raise wages, it just inflates another bubble.

5. Slows equity growth

A long mortgage term builds equity slowly, so homeowners have less to tap into if they want to downsize, relocate, or take out a home equity loan. …

After a decade, the 50-year borrower has less than half the equity despite paying only ~$196 less per month.

More disses courtesy Twitter. The first focuses on a critical issue, that just about no one would keep a home for the life of the mortgage, and the impact of the longer maturity and higher interest on typical ownership terms. This is similar to the point we made at the top, that a longer-term mortgage with a refi will result in more money going to middlemen, and also means more money will have gone to interest if you sell the house before maturity, so less in principal recovery and gains if any:

Freddie and Fannie nevertheless will spend money devising standard mortgages at these 50 year terms and promoting them to lenders. And DOGE will peculiarly fail to head this wasteful expenditure off at the pass.

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1 Nerdy detail for the curious, from the same post:

The structuring of Freddie and Fannie bonds is to deal with interest rate risk (remember, there is no credit risk since the bonds are guaranteed by the GSEs). This is well established technology, dating back to the early 1980s.

The undesirable feature of mortgages is their prepayment risk. Every country ex the US has features in mortgages that restrict or prohibit prepayment risk (the most common is having mortgages be floating rather than fixed rate). Prepayments are very unattractive to bond investors, since the time you are happiest as a fixed income investor is when interest rates fall, since your bonds go up in value. But if you hold a simple mortgage pass-through, the bond will disappear due to prepayments.

So the structuring of a CMO (collaterlialized mortgage obligation) creates a series of normal looking bonds from the cash flows from mortgage securities: some fixed interest rate bonds of various maturities (created at a lower interest rate than the yield on the mortgages) and one medium-term maturity fixed rate bond which is then decomposed into a floating rate bond and an “inverse floater” which consists only of the inverse of the interest rate payments on the floating rate note (for instance, if the coupon on the bond from which it was decomposed was 6% and the rate on the floater is Libor + 8 basis points, or .08%, the inverse floater would pay at 6% – (Libor + .08%).

There are some dirty little secrets of inverse floaters. The first is that because the other parts of the deal are very to extremely easy to sell, various features of the deal structure are tweaked to favor the inverse floater, plus the other components are often sold at premiums, meaning some additional cash flow can be diverted to the inverse floater. This is useful because the inverse floater is colloquially called “toxic waste.” It is very difficult to sell and usually retained by the originator because it is hard to explain, hard to model, and has widely divergent payouts depending on what interest rates and prepayments do.

The second dirty secret is that all the feature tweaking makes inverse floaters a good bet on average. On a $100 million bond deal, you might expect $2 million of the value to be in the inverse floater. All the eagerness of the other buyers for the other pieces means you can probably rejigger terms during the deal structuring for it to be expected to be worth $3 million. If you are smart and disciplined, you book it at $2 million, so that if things work out, you look like a hero. and if events pan out otherwise, you look like less of a goat.

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2 comments

  1. Michaelmas

    End-stage neoliberal asset inflation and financial extraction.

    America isn’t a country, but a business — a plantation. Mr. Fishback is in the denial stage of the Kubler-Ross cycle of accepting this.

    Reply ↓
  2. Norton

    I’m interested in finding out more about the refinancing capture of 2/3 of the economic benefit. That seems like an underreported issue.
    Where do I find out more details? Thanks.

    Reply ↓

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