Why 50-Year Mortgages Fall Short
Federal Housing Finance Agency director Bill Pulte recently floated a big potential change to the mortgage market: 50 year mortgages. Unfortunately, these aren’t realistic.
Typical mortgages last 30 years. Extending them to 50 years would have the benefit of lower monthly payments for borrowers. However, the idea has several issues.
The basic idea is a non-starter from the mortgage holder point of view. They need to hedge away their interest rate risk, or “duration”. If rates rise, then the value of the loan goes down. Therefore, the mortgage holder will short Treasury bonds of the same maturity to make themselves duration neutral. If interest rates move up, then both the loan and the treasury bond will lose value equally if balanced appropriately. The mortgage holder will only profit off of the spread between the Treasury yield and their mortgage rate, and be protected from moves in the interest rate.*
But a 50 year Treasury bond doesn’t exist, and it’s doubtful that one would ever be issued. There is enough demand for lower terms that a 50 year Treasury bond would carry an illiquidity premium, on top of the extreme inflation premium. Unless the national deficit balloons massively, there won’t be a funding need for it.
Even if this bond did exist, a 50 year mortgage would be horrible for borrowers, causing them to pay significantly more interest over the period of the mortgage. See the image below for a comparison of a $400k principal mortgage. The 50 year rate is guaranteed to be higher than the 30 year rate to compensate for the increased duration, credit, and inflation risk. Paying an extra $500k in interest is extreme, and dangerous when most people don't really understand interest to begin with.
Pulte has pulled back from his enthusiasm on the 50 year mortgage after the market responded negatively. However, given the explicit cosign of President Trump, we might continue to hear about this… or they’ll move onto a new product, like portable mortgages. But that’s a subject for another day.
Read more at Bloomberg: https://lnkd.in/edU-T2Zx Trump’s 50-Year Mortgage Loses Steam as Industry Questions Costs
*Treasury bonds do not make a perfect hedge, because mortgages can be refinanced, introducing negative convexity (short gamma) into the asset. Portfolio managers will long gamma (e.g. a payer swaption) to neutralize this cost. The same liquidity problems exist.