A Mortgage For Baby Boomers Facing Retirement

February 9, 2010

“I am 58 years old and looking to buy a new home. I won’t be able to pay off this home before I retire, but I would like my payment to drop at retirement because my income will drop. I was thinking that a combination of a 15-year and a 30-year mortgage might work for me because the 15-year portion would be paid off about the time I retire. What do you think of this idea?”

 

It is interesting. If you borrow $100,000 at 5% for 30 years, your payment is $537 for 30 years. If you take a 15-year at 4.5%, the payment is $765 for 15 years. If you borrow $50,000 of each, the combined payment is $651 for the first 15 years, and $269 for the next 15 years. This is the kind of deal you are looking for. Obviously, the portion of the combination that is 30 relative to the portion that is 15 could be adjusted to your individual circumstances.

To my knowledge, however, no lender is offering this kind of combination loan. The major thrust of mortgage innovation has long been to find ways to reduce early year payments, at the expense of higher payments in later years. All such mortgages carry additional default risk because they all carry delays in paying down the loan balance. In contrast, the combination loan you are looking for would reduce default risk because of larger payments in the early years, and should therefore be attractive to lenders. Presumably the reason it doesn’t exist is that nobody thinks there is much of a market for it. In this, they may be wrong.

Of the mortgages now available in the market, the one that comes closest to meeting your needs is the 10/1 adjustable rate mortgage (ARM). This loan is fixed-rate for 10 years, and when the rate is adjusted, a new payment is calculated that will fully amortize over the remaining 20 years. The new payment is based on the balance after 10 years, so the extra payments you make during the first 10 years will result in a lower payment starting month 121. Further, after 10 years, the payment is recalculated annually with a new interest rate, so that any extra payments made during the year will reduce the payment in the following year.

The weakness of the 10/1 ARM for your purpose is that every recalculation of the payment is made at the then current interest rate, and a rise in rate could offset the effect of your extra payments. The risk is considerable. While rates can go up or down, over the next 10 years they are much more likely to go higher than lower.

What is needed to meet your needs is a mortgage that operates like an ARM in having the payment recalculated at periodic intervals, but with a fixed rate for the life of the loan. The initial payment period could be set to equal the borrower’s high-income period. At the end of that period, a new payment would be calculated that would be lower to the extent that the borrower had made extra payments during the first period. This would be a very simple instrument designed to meet a specific market need.  

 

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