40-year amortization allowed? - Posted by Matthew Chan

Posted by John Behle on April 26, 2000 at 23:10:12:

If you want to post the terms or sample terms, we can map out some options.

And yes, 10 years is better than an earlier balloon, but it still doesn’t deal with the problem of what is the market like, their finances, their credit, their income, interest rates, etc.

40-year amortization allowed? - Posted by Matthew Chan

Posted by Matthew Chan on April 26, 2000 at 16:37:04:

In providing owner-financing to someone, is there any rule or law that says we cannot do a 40-year amortization or do a 40 year loan? I am guessing that I should be able to do it as long as both buyer and seller is agreeable.

Note buyers and conventional lenders probably wouldn’t allow it though…

Obviously, this is very interest heavy to the payor but it would allow lower monthly payments.

Any thoughts or opinions?

Re: 40-year amortization allowed? - Posted by Eric C

Posted by Eric C on April 26, 2000 at 23:28:16:

Hi -

Interesting discussion. There was a developer in my town who made his fortune by creating new single-family subdivisions, building all the houses, and then carrying all the financing!

Most of his deals were 40 year amortizations. His intent was to lock in a buyer with as low a payment as possible so as to compete against other builder/developers.

It worked very well. He has been dead almost fifteen years and his heirs are still collecting payments from hundreds of families.


Eric C

PS - for what it’s worth, I’ve never heard a bad word about him from his homeowners/buyers either. He built a good unit, offered attractive financing, and made it possible for them to raise their families in a nice environment.

Savings of Am. had 40 year loans - Posted by Bud Branstetter

Posted by Bud Branstetter on April 26, 2000 at 21:04:48:

Savings of America had 40 year ajustable loans back in the late 80’s. I still have one. 7 1/2% now. It was 40 year only if you pay the minimum. As said by John Behle and Eduardo you usually do things other ways. Payments out that far aren’t worth much to a note buyer. I like the graduated interest. It gives a lower payment at first then starts going up. The buyer can determine when he wants to refi.

40 line (or so) response - Posted by Eduardo (OR)

Posted by Eduardo (OR) on April 26, 2000 at 18:47:00:

Hi Matthew–

30 year mortgages became the standard after World War II when returning servicemen needed to buy housing and had little money for downpayments. Why not 20 years or 40 years? There is a mathematical curve (you can use your calculator to figure this out) whereby the longer the term of the loan, the less the monthly payment goes down (assuming the interest rate stays the same). The monthly payment drops considerably between a 10 year loan and a 20 year loan. Less so between a 20 year loan and a 30 year loan. Hardly at all between a 30 year loan and a 40 year loan. It was thought at the time that 30 years represented a reasonable compromise between number of years to pay and low payments. For example, The monthly payment of a fully amortized $50,000 30 year loan at 10% is $438.79. Over that period of time, the payor pays out almost $158,000 in principal and interest (over $100,000 in interest alone). The same loan at 40 years has a monthly payment of $424.58. Over $200,000 is paid out over the 40 years (over $150,000 in interest), yet the monthly payment is only $14.21 less–the price of a one large pepperoni pizza and 2-liter bottle of diet coke per month!

There is more to the story. Another reason the 30 year mortgage became a standard (not only with FHA and VA loans, but with the entire lending industry) is that people get married, have kids, and start buying homes usually when they are in their 30’s. They want to retire in their 60’s. Most analysts recommend having your house paid for when you reach retirement age and your income drops. It is interesting to note that in Japan, for instance, they have “two-lifetime mortgages.” Because of the scarcity of land there and the resulting extremely high prices for housing, once a person saves up the downpayment, he commits to a mortgage payment not only for the rest of his life, but his heirs as well.

Back to your point. 40 year mortgages are few and far between and may be seen most often with properties like a farm or ranch where a lot of money is involved, lower payments would be signficant, and the buyer can expect to make the payments from the income the farm or ranch produces over the years. With residential housing 40 year loans are almost non-existent. For this reason I would not recommend sellers trying to talk buyers into them. If the buyer is unsophisticated and can show in court that the idea came from the seller, there is a chance that the court may hold that the seller (who was a real estate investor and therefore can be assumed to have superior knowledge) forced the buyer into an unconscionable contract. Thus, if the buyer becomes dissatisfied, the contract may be overturned by the court. (The same is possible with, for example, an interest-only loan with no due date–I’ve seen those.) (There is no reason I can think of why the buyer would ask for a 40 year loan.) You might consider, though, a compromise such as a 35 year mortgage. I’ve seen several of these agreed to between buyer and seller in owner-carryback situations. If you decide to get involved in one of these, it might be a good idea to document in the paperwork the reason for having a loan of a longer than normal term just in case the buyer decides to object later. Also, I’m sure you know that anything two people can agree to to, they can “unagree” to at any time. Rewriting an owner-carryback loan at a later date to accomodate the payor gives opportunity to increase the yield. --Eduardo

Re: 40-year amortization allowed? - Posted by Joe

Posted by Joe on April 26, 2000 at 18:46:29:

There has been in the past some 40 year farm loans with flexable payment schedules based on crop production.
But look what happened to farming in the 80’s and so on. I wouldn’t write the loan. Go with a balloon if you want lower payments, etc.

Good Luck in REI

I mean’t NO there isn’t a law against it and YES 40 yrs is fine. - Posted by John Behle

Posted by John Behle on April 26, 2000 at 18:44:55:

just to clarify.

Re: 40-year amortization allowed? - Posted by Doug Pretorius

Posted by Doug Pretorius on April 26, 2000 at 18:35:31:

A balloon would also lower monthly payments and would probably be more salable than a 40-year mortgage. Unless of course you have no problem with waiting for 40 years to get your money?

No (nt) - Posted by John Behle

Posted by John Behle on April 26, 2000 at 18:35:00:

Wow, the shortest post I’ve ever made.

Re: Savings of Am. had 40 year loans - Posted by Matthew Chan

Posted by Matthew Chan on April 26, 2000 at 22:04:09:

Yeah, I can see where those future payments might only be worth a nickel! :slight_smile:

40-year loans would not be my first choice to do but all of you have answered my question. It is allowable with some special considerations.


Re: 40 line (or so) response - Posted by Matthew Chan

Posted by Matthew Chan on April 26, 2000 at 19:31:38:

Thanks for the thorough reply. I’ve been running across some homes that are a little more expensive than the tenant/buyers I have lined up can afford. And I was trying to find a way to “close the gap” a little more.

It’s funny you mention the “compromise” between a 15, 20, and 30 year mortgage. I noticed the differences with the shifting “sweet spot” in my own calculations. It’s kind of amazing actually. You can pay up to 10 years and still have so little principal paid down on a 30-year note.

No wonder Kiyosaki says to not consider your own house an asset. Most of the equity you get will come from appreciation (or buying something that has lots of equity already), certainly not from loan paydowns.

No, the buyer would not ask for this specifically. It was a possible “solution”. Remember, most buyers are only concerned with how much down and how much a month, right? :slight_smile:

Re: 40-year amortization allowed? - Posted by Matthew Chan

Posted by Matthew Chan on April 26, 2000 at 19:21:12:

I simply don’t believe that most 30-year loans ever go to term much less a 40-year one. Statistically, I think loans only last 7 years or so before they get paid off.

I suppose it’s possible that one could run that long but if my life is being greatly affected by the occasional one that runs that long, there is something else wrong with my financial situation.

Another long response… - Posted by Eduardo (OR)

Posted by Eduardo (OR) on April 26, 2000 at 20:47:04:


Yes, it is interesting. On my two examples above, the balance owing on the 30 year loan is still one-half ($25,000) of the original $50,000 after 23 and one-half years of making monthly payments, and the balance on the 40 year loan doesn’t reach one-half until one has been paying on the loan for 33 and a quarter years. It takes over 83% of the 40 years of this loan to get the balance down to one-half what you started with (over 78% on the 30 year loan. And this at a reasonable 10% interest rate! (Most people don’t know how amortization works–some people think their loan will be half paid off at the halfway point of the term.)

But, knowing how to use the financial calculator can really work to the investor’s advantage. For example, when buying property it may be much better to assume an existing loan than creating a new one, and when selling it may be much better “wrapping” an existing loan. For instance, when buying: If the existing loan is “seasoned” (been in existence for several years) and you have a relatively low interest rate, then assuming that loan, with the seller carrying back a favorably structured “second” may be the way to go for the following reason: More of the monthly payment on older, low-interest loans goes to principal reduction and less to interest. You play with your calculator to figure out the various scenarios. To give a real-life example, I bought a property that has an owner-carryback loan at low-interest that has been in existence for a number of years (it was originally a 30 year loan). My monthly payment is $266.13 (the property is worth about $150,000), but of that $266.13, a little over $100 goes to reduce the principal each month. That is like paying myself $100 a month because my net worth is going up by that amount each month. So, I like to think that I am really paying only $166.13 a month for this property and it only gets better as time goes on. Would I pay it off early? No way! If I decide to sell, I will wrap this loan with another long-term higher interest loan (I made sure there would be no due-on-sale clause when I bought the property). By the way, my tenant, of course, is buying the property for me–his rent covers all my expenses and gives me a nice positive cash flow. (And no, my downpayment wasn’t that much.)

You can be so creative with owner-carryback financing that I can’t understand why anyone would use institutional financing. To each his own, I guess. --Eduardo

Consider interest only or graduated payment too. - Posted by John Behle

Posted by John Behle on April 26, 2000 at 20:08:21:

The dilemma is the buyer wants to pay as little as possible and the seller wants money soon.

Balloon payments are the “almost” creative option some have come up with, but there are more problems created. A balloon payment is a foreclosure in embryo.

It explodes or pops in an uncertain market in an uncertain future. Will financing be available? Will it be reasonable? Will the buyer be able to qualify? All good questions and many a buyer, seller and real estate agent have been burned when the ballons do explode.

Anyway, consider a graduated payment instead. Start at a figure that the buyer can afford and raise the payment a little each year. The loan can easily amortize in 10-20 years without any undo pain to the payor. The payments go up as their income does. If and when they start becoming uncomfortable, the payor can refinance at an “opportune” time if they want - instead of having it thrust upon them through a balloon.

Re: 40-year amortization allowed? - Posted by Doug Pretorius

Posted by Doug Pretorius on April 26, 2000 at 22:03:39:

That’s a good point. And with the assumably higher interest, they may be more motivated to pay-off early.

One point of emphasis… - Posted by Mark (SDCA)

Posted by Mark (SDCA) on April 27, 2000 at 11:32:05:

You are 100% on the money about the mortgage paydown… There are 2 hilites to every one of my months. The first is early in the month when I go to the bank to deposit rent checks. The 2nd is in the middle of the month when I figur eout the mortgage paydown. Most of my loans are still relatively new so it is not a lot of money per property. But multiply it by the number of properties and it is over $1000 per month. And it will ONLY go up. So I am “earning” $1000 for making a trip to the bank and writing out a few checks. That is why I love buy and hold…


Adding to your thoughts… - Posted by Matthew Chan

Posted by Matthew Chan on April 26, 2000 at 21:56:39:

And to add to your train of thought, negotiating something as small as $100 rent credit for a modest house ($100k) lease/option that you want to control actually builds equity faster than if you were to get an equivalent “conventional loan” on $100K.

I used to think I knew amortizations. But it never really hit me until I LOOKED at the schedule and notice how small the principal is for so many years!

So, I am in agreement with you. I am fairly resistant to institutional financing now as well. It is all in the numbers.

Thanks again for the feedback.

Balloon selections… - Posted by Matthew Chan

Posted by Matthew Chan on April 26, 2000 at 22:00:53:

What would be a “safe” balloon then? I spoke to an institutional buyer and we were kicking around the idea of a 10-year balloon being relatively safer since it is out of normal bounds when a loan gets paid off and it gives plenty of time for appreciation.

Would that be better?

7 year balloon - Posted by Bud Branstetter

Posted by Bud Branstetter on April 27, 2000 at 22:06:36:

If you remember Tony Hoffman he had a guideline about balloons. You never commit to a balloon for under 7 years. The reason was that historically within that 7 year period you will have low interest rates in which you can refi or you will have inflation that raises the value and you can refi. The bottom of the interest rate was about a year and a half ago. Guess what comes next?