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.
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?
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.
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?
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.
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)