Retired professor of philosophy and logic who blogs on social, political, and economic issues. After serving in the U.S. Army during the Korean War, he spent 20 years as a university professor and another 20 years working as a writer for various private companies. He’s an active blogger. His pieces can be found on http://www.jkozy.com/.
Have you ever wondered why the standard terms for mortgages are 15 and 30 years rather than 10 and 20 or 25 and 50? I have, but was never able to find a satisfactory answer. Then I discovered something interesting. Since this country was founded, downturns in the economy have occurred on an average of once every 14.5 years. This similarity may, of course, be sheer coincidence. But I'm suspicious.
Why?
Well, if you amortize a standard 30 year mortgage at six percent interest, you'll discover that the lender gets all of the money it has invested back in 13 years and 11 months.
Now look at what happens to a home buyer who takes out a mortgage just after an economic downturn, pays on it for 14 years, a downturn strikes, and then for whatever reason cannot sell his home and defaults. The lender gets the house and the buyer has lost all the money he/she has put into it.
But look at what happens to the lender. It has already gotten its initial investment back, so in reality it loses nothing. But now it has a house to sell. How much has the lender paid for this house? Nothing! So it sells the house to another buyer by providing another mortgage. Now if the initial buyer had continued to pay the loan to term, the lender would have earned about as much as the initial investment. But now everything the second buyer pays is pure profit, not just the computed interest. In reality, the total amount of the mortgage loan is earned interest on an investment of zero. Wouldn't you like to find a way of doing that?
Of course, such situations don't come about often. Although the average time between economic downturns is 14.5 years, downturns happen at varied intervals. And even in downturns, many people forced to sell their homes usually can. But it doesn't take many who can't to make lenders a lot of money. Just five people forced into the situation described with $100,000 loans would net a lender a hefty one million free dollars. If the loans are larger, the lender nets even more. And, of course, the numbers are different for different interest rates. But the principle is the same. Lenders almost always get their initial investments back in half a loan's term or less.
©2009 John Kozy
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