MEDIA RELEASE 40 year Loans by alendar


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									                                                                               Daryl Hill
                                                   Head of Distribution – Group Executive
MEDIA RELEASE                                                           FEBURARY 2006
40 year Loans
 How can mortgage providers improve affordability for home buyers? The simple answer is to increase
the maximum loan term. Currently for most Australian financial institutions, the maximum loan term is
30 years. However, in both the US and the UK it is not uncommon to offer a 40 year mortgage.

According to the latest figures form the Australian Bureau of Statistics (ABS) the level of housing
affordability has not changed in Australia over the last 24 months. However, the impact of the property
boom at the beginning of this decade has left a big gap between housing prices and consumer spending
power. The consumer price index (CPI) (shown in chart 1) has increased by an average of 3% p.a. over
the last four years – barely comparable to the increase in housing of 10% p.a.

40 year mortgages are attractive to low income borrowers seeking an entry point to the property market.
Properties that were out of reach with a 30 year mortgage suddenly become affordable when the
repayments are spread over an extra 10 years.

Surprisingly the US experience suggests that 40- year mortgages are now also the home loan of choice in
the luxury home market. These products have attracted home buyers at the high – end of the housing
market. These are people wanting to leverage themselves into homes in the next price bracket or who
simply have better alternatives for their cash flow than to pay off their own home.

Product initiatives that could improve affordability for Australians would seem appropriate in the current
environment. The recent retraction in prices across most housing markets has restored hope for some
buyers, but this may be short-lived given the lingering threat of a future rate rise. But there are two sides
to the 40-year mortgage story.

Pros and Cons

The primary advantage of a 40-year mortgage stems from simple math. By extending the repayment term
by an extra 10 years, the monthly repayments become more affordable. For example, on a $250000 loan,
the repayments on a 40-year mortgage are approximately $100 lower per month than the repayments on a
30-year mortgage. This reduction in payments is equivalent to the reduction in repayments resulting from
a 0.63% fall in interest rates.

Improved affordability is the upside.

Moving the mortgage term from 30 years to 40 years translates into lower monthly repayments of the
principal. However this not only means that the equity in the home is built up at a slower pace, but it
means a significant difference in the cost of borrowing if the loan is in place for the full term. In our
example the 40-year loan cost $150,000 more than 30-year loan, over the full life of the loan. Clearly
there is an impact on an individual’s longer term financial goals that need to be weighed against the
advantages of the property purchase.

La Trobe Financial                                                            -2-

Table 1 Advantages and Disadvantages of 40-year model
                  Advantages                                       Disadvantages
1.0 Lower monthly repayment                       2.0 Slower equity growth
3.0 Increase borrowing power                      4.0 Paying more interest due to longer term
                                                  5.0 May increase overall housing debt

Does Australia need a 40-year mortgage?

With Australians’ appetite for properties remaining strong and concern over household debt rising, this
product is likely to evoke strong arguments on both sides. In recent years innovation in the Australian
mortgage market has attracted criticism. Line of Credit products and Reverse Mortgages have placed the
industry under intense scrutiny because they have effectively changed the risk profile of home lending.

But how real is this risk? Borrowers rarely take a home loan with the intent of paying it off over the full
30 year term. These days the average life of a mortgage is less than 4 years. After this time people
typically trade up to a bigger property or restructure their loan to accommodate their changing
circumstances. Therefore, the cost impact of a 40 year mortgage as opposed to a 30 year mortgage is
likely to be minimal and for many, validated by the opportunity to purchase a property that would
otherwise be unaffordable.

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