40 Year Mortgages
The 40 Year Mortgage Loan: Pros and Cons
by Nancy Osborne, COO of ERATE
Similar to the traditional 30 year mortgage, with an amortization term 10 years longer, the 40 year loan could help a borrower achieve greater purchasing power in getting into a home they could not otherwise afford by reducing their monthly payment and stretching it out over a longer time horizon. The 40 year mortgage has been around for several decades and goes in and out of popularity based on current interest rates and housing prices. The 40 year loan term has been most prevalent in those areas where housing costs have exceeded a region's growth rate of income. However before proceeding with a 40 year loan, a borrower should carefully weigh all the options and consider exactly what they hope to gain from the 40 year versus other types of loans available. The following are some pros and cons to think over before making the move into a 40 year mortgage:
- The loan appeals to first time buyers who hope to buy more home. The lower payment makes handling their first mortgage far more manageable. It also means extra disposable monthly cash on hand which many new home buyers frequently discover they'll need.
- It may be a safer, less volatile alternative to an adjustable rate mortgage, the 40 year mortgage offers a fixed rate for a longer period of time. However some of the 40 year loan products are actually balloons, or 40 due in 30 year loans, which are amortized over 40 years but due and payable in 30 years.
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- Could be a good option at times when a higher interest rate climate exists as a 40 year loan may offer a lower payment alternative to other shorter term mortgages. As most consumers tend to maintain a mortgage for an average period of only 5-7 years before selling the home or refinancing, this initial payment relief can be welcome. Hopefully the 40 year term borrower can refinance into more attractive financing options in the future as their income grows.
- Attractive to high wage earning households whose primary tax deduction is that of mortgage interest. (However it's possible the interest only mortgage may prove to be a less costly, more effective alternative to consider).
- May be beneficial to borrowers who plan to remain in a property indefinitely as this will lessen their risk in taking on a long term mortgage if rates were to increase and they were unable to refinance or in the event that housing prices declined.
- The tradeoff of a lower payment with the 40 year mortgage comes at a price, it is offset by a higher interest rate, typically .25% to .50% higher than that of the 30 year fixed rate mortgage.
- The real savings, in actual percentage terms, with a 40 year payment versus other loans can be deceiving. It is estimated that to extend the term an additional 10 years, in going from a 30 year to a 40 year loan, may only translate into a true savings in payment of slightly over 8.0%. This is far less than the payment savings achieved in expanding the term from a 10 to a 20 year and a 20 to a 30 year.
- The longer loan term results in a much slower rate of growth in equity for the homeowner unless they were to make significant pre-payments of principal to offset this.
- The higher interest rate on the 40 year loan results from the added risk to the lender due to the slower growth rate of a borrower's equity position in their home (the smaller the equity stake, the greater the likelihood of payment default). In lieu of a higher interest rate, lenders may require a borrower to make a larger down payment to help offset this increased risk.
- Superior rate products are available such as short term ARMs: one, three and five year adjustables as well as fixed rate buydown products and interest only loans may produce a benefit similar to that of the 40 year mortgage yet carry a lower rate of interest and therefore a lower overall cost to the borrower.
Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.
"I am addicted to Bloomberg TV" says Nancy.
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