Do 40-Year Mortgages Make Any Sense?

April 18, 2012 3 Comments »
Do 40-Year Mortgages Make Any Sense?

Every now and then, I’ll take a look at a certain mortgage product to determine if it could be a good fit for a prospective (or existing) homeowner.

Today, we’ll digest a relatively popular home loan option, the “40-year mortgage.”

You may already be thinking, “40 years? I thought mortgages had terms of 30 years?”

Well, you’d be mostly right. The majority of mortgages issued today do have terms of 30 years.

In fact, aside from 30-year fixed mortgages, which clearly last for 30 years, adjustable-rate mortgages also have terms of 30 years.

So that 5/1 ARM or 7/1 ARM you’ve got your eye on still has a 30-year term, meaning it’s fixed for the first five or seven years, then adjustable for the remaining 25 or 23 years, respectively.

Why a 40-Year Mortgage Term?

Okay, so we know the 40-year mortgage bucks the trend here, and adds 10 years on to the standard mortgage term. But why?

Well, the longer a mortgage amortizes (is paid off), the lower the monthly mortgage payment. Essentially, payments are stretched out over a longer period of time.

Let’s look at an example:

Loan amount: $300,000
30-year fixed: $1410.71 @3.875%
40-year fixed: $1300.86 @4.25%

As you can see, the monthly mortgage payment on the 40-year mortgage is roughly $110 less each month.

You may have also noticed that the mortgage rate on the 40-year mortgage is 0.375% higher than the interest rate on the 30-year fixed.

Put simply, you pay a premium for a longer amortization period. This is the opposite of a 15-year fixed, where you receive a discount for paying your mortgage off faster.

Still, the short-term savings can increase how much house a buyer can afford, and also make qualifying easier (or even feasible) if a borrower’s debt-to-income ratio is too high for a 30-year mortgage.

This is essentially why a borrower would go with the 40-year fixed – to buy more house or make their mortgage more “affordable.”

More aggressive borrowers could even invest that $110 each month in a high-yielding retirement account and essentially try to beat the relatively low interest rate on their mortgage.

The Downsides of a 40-Year Mortgage

While this all sounds good, a borrower who chooses to go with a 40-year mortgage is paying a premium to do so.

The mortgage rate is higher, so that cuts into the “discount” afforded by a 40-year mortgage.

And while the monthly mortgage payment may be lower, the total interest paid over the full term will be much higher, which makes one question whether $100 or so in monthly savings is worth it.

On smaller mortgages, the payment different will be even more negligible. It may also be difficult to find a 40-year mortgage, since not all lenders offer them.

Additionally, a longer amortization period means you build home equity a lot slower, which could prove to be an issue if you need to sell or refinance in the future and your loan-to-value ratio is still sky-high.

Still, one could argue that most homeowners don’t stick with their mortgage full term anyways, let alone for 10 years, so why pay more each month?

A 40-year mortgage could also serve as a good alternative to an interest-only home loan, which won’t build any equity, and could land a homeowner underwater.

It’s also safer than an ARM (assuming it’s a 40-year fixed), which can adjust higher once the fixed period comes to an end.

As always, do plenty of homework (and math) and consult with a loan officer or mortgage broker to determine what’s best for you and your unique situation.

Tip: You may come across a “40 due in 30” as well, which is essentially a 30-year balloon mortgage that amortizes like it has a 40-year term.

(photo: Derek Swanson)

3 Comments

  1. Rolland September 22, 2013 at 3:46 am -

    Aren’t mortgages longer than 40 years banned now thanks to the new Qualified Mortgage rules?

  2. Colin Robertson September 25, 2013 at 10:07 am -

    Loans with terms that exceed 30 years will not qualify for QM come January 2014, but certain lenders will probably still offer non-QM loans that feature 40-year terms. They’ll just be harder to come by, and probably more expensive.

  3. Marina December 20, 2013 at 3:10 am -

    No lender will offer loans with 40-year terms anymore thanks to QM. And even if they do, they’re a bad choice for most homeowners.

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