40-Year Mortgages: Do They Make Any Sense?

40-Year Mortgages: Do They Make Any Sense?

Interested in a 40-Year Fixed Mortgage?

  • If you need even more time to pay off your mortgage
  • A 40-year fixed could be one alternative
  • But they’re harder to come by these days
  • And aren’t well-suited for everyone

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

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

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

Well, you’d be mostly right. The majority of mortgages issued today do have terms of 30 years. It’s certainly the most common loan term out there.

In fact, aside from 30-year fixed mortgages, which clearly last for 30 years, as the name implies, adjustable-rate mortgages also have terms of 30 years, despite lacking any reference to 30 years in their title.

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. This is one reason why consumers have a great amount of difficulty understanding mortgages.

Only the 15-year mortgage and 10-year fixed come with different loan terms, 15 and 10 years respectively.

Why a 40-Year Mortgage Term?

  • It’s an extra 10 years over the typical 30-year loan term
  • Offered as a means to lower monthly mortgage paymnets
  • Which can make the home loan more affordable
  • But also lead to a lot more interest paid over the longer 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? What’s the point of paying a mortgage for an extra decade? That sounds like a literal lifetime commitment.

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. Instead of 360 months, you’re looking at 480 months.

Let’s look at an example of a 40-year fixed mortgage:

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 thanks to that longer period of time to pay it off.

That extra cash could be used to pay off student loans, credit cards, personal loans, and other higher-APR debt you may have, or to set aside cash for an investment property. It could also make a real estate purchase slightly more affordable.

The bad news is you’ll pay much more interest over the life of the loan, and it’ll take a very long time to build a meaningful amount of home equity.

If you use a mortgage calculator, make sure it’s set at 480 months. And pay close attention to how much interest is paid versus a loan with a term of 360 months. It’ll be an eye-opener.

40-Year Mortgage Rates Are Slightly Higher

  • Expect 40-year mortgage rates to be slightly higher
  • Than interest rates on 30-year fixed mortgages
  • How much higher will depend on the lender in question
  • And your unique loan scenario

You may have also noticed that the mortgage rate on the 40-year mortgage in my example is 0.375% higher than the interest rate on the 30-year fixed. That’s not random.

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.

After all, a bank or lender is willing to give you a fixed rate for four decades, so they’re going to want a slight premium in exchange for all that uncertainty.

Today's Rates

In other words, expect 40-year mortgage rates to be slightly more expensive. It might only be .125% higher than the 30-year, but could definitely range from bank to bank. The bigger problem is finding a lender that offers the product to begin with.

That being said, 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. That’s assuming the lender qualifies the borrower at the 40-year loan payment…

This is essentially why a borrower would go with the 40-year fixed – to buy more house or make their home loan 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.

Nowadays, a 40-year mortgage term may even be part of a loan modification program to make payments more affordable for a struggling borrower. When combined with an interest rate cut on their current mortgage, the combo can help a borrower stay put in their home for the long haul.

The Downsides of a 40-Year Mortgage

  • Loan is paid much back slower (harder to build equity)
  • Most of the mortgage payment consists of interest
  • May not be much cheaper than a 30-year fixed
  • And they’re not easy to find these days

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

As mentioned, they are higher-rate loans, so that cuts into the payment “discount” afforded by a 40-year mortgage.

And while the monthly mortgage payment might be lower, the total interest paid over the full loan 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.

In fact, the Qualified Mortgage rule outlawed loan terms longer than 30 years, so 40-year mortgages aren’t even QM-compliant. That means you’ll probably need to go with a specialty mortgage lender or portfolio lender if you want one.

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

Some Benefits to a 40-Year Mortgage

  • Could be a good short-term solution
  • If you need monthly payment relief
  • And don’t plan on staying in the property for very long
  • But you pay for the privilege

Still, one could argue that most homeowners don’t stick with their mortgage full term anyway, let alone for 10 years, so why pay more each month? Or worry that it’ll take forever to pay it off?

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

These mortgage types are also safer than an ARM (assuming it’s a 40-year fixed rate), which can adjust higher once the fixed period comes to an end. So you won’t have to contend with any rate adjustments, which could make it easier to sleep at night, especially if you’re a first-time home buyer.

As always, do plenty of homework (and math using a mortgage calculator) 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. That keeps monthly payments low, but there is a balance due at 30-year mark. Again, most of these probably aren’t kept full term, so it might be moot.

(photo: Derek Swanson)


3 Comments

  1. 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.

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

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

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