Question

What are the advantages and disadvantages of various mortgage maturities? Some people feel that home mortgages should be paid off as quickly as possible. Others believe that mortgages should take as long a period of time to pay off as possible. How does the term period of a home mortgage impact an individual's cash flow? Which is more relevant, the length of the mortgage, the interest rate, or both? Explain your choice, and use real- world examples to support your position

Answer 1

Mortgage maturities can help you achieve the asset liability maturity match. A real life example will be a company raising debt to finance a long term asset. Let's say the asset takes two year to build and start operations. In that case, the firm will choose a mortgage that matures after two years so that the cash flows from the assets can be use to pay off the mortgage.

A long maturity mortgage has an advantage of lower monthly or periodic payments. This eases the cash flow pressure on the borrower. The disadvantage is that the borrower ends up paying higher interest over longer tenure of the loan.

A shorter maturity mortgage advantageously will have lower payout towards interest as the debt remains outstanding for a shorter period of time.

In case of a home mortgage, the borrower has to make a monthly payment to the lender. The monthly mortgage payment usually takes away the 60 - 70% of the monthly income leading to a huge pressure on the borrower. The monthly mortgage payment is a function of the tenure or maturity of the home loan. The monthly payout will be higher in case of shorter maturity but lower in case of longer maturity. However, the total payout towards mortgage (principal + interest) will be higher in case of mortgage with longer maturity.

For a borrower, both the interest rate as well as the length of the mortgage is relevant. In my personal opinion, interest rate is more relevant. I will prefer a loan with lower interest rate. I can always play with the length of my mortgage either by prepaying or by increasing my EMI if my income level permits so. Hence, I have some control on the tenure of the mortgage, but I will have no control on the interest rate.