What Is A 40-Year Fixed Mortgage And Should I Get It?

The Advantages Of A 40-Year Mortgage

The housing market has become so stretched that the affordability ratio for first-time buyers has deteriorated to levels last seen in the third quarter of 1989. Bids evaporated and new home sales dropped 20% in response to the situation at that time.

Sky-high prices are not preventing cash-strapped consumers now from getting the house of their dreams because lenders are letting them drag out the term of their mortgages to 40 years. By doing so borrowers can stretch out loan payments and qualify for larger mortgages with lower payments.

With house prices soaring, the 40-year fixed-rate mortgages was created by several California savings and loan associations and can now sell loans to Fannie Mae, the nation’s largest mortgage finance company.

Real estate brokers and lenders say consumers are being resourceful in taking out 40-year loans when double-digit home price appreciation has become the norm.

Most borrowers do not plan to live in the house for 20 years, so a long term is of no consequence. They figure to sell in about seven to ten years having many years left on the term of the loan remaining anyway.

The primary advantage of a 40-year fixed-rate mortgage is making monthly payments more affordable without taking on the risk of an adjustable rate. In addition to buyers in high-cost areas, the 40-year fixed mortgage also appeals to buyers with small down payments.

Reducing the monthly payments on large loan amounts is accomplished by stretching the repayment term by an extra 10 years. And you might save a hundred a month over those decades on the smaller monthly house payment.

The Disadvantages Of A 40-Year Mortgage

Many financial advisers, attorneys, and mortgage-consulting firms are more than concerned about the new 40-year loan.

Some of this effect of lower monthly payments is negated by a higher rate that is charged on the 40-year loan. Rates on a 40-year fixed are often one quarter to one half of a percentage point higher than a traditional 30-year fixed-rate mortgage.

Loans with longer terms carry higher rates because of the added time frame where a default may occur and because lenders seek compensation for the longer period of time that their money is tied up.

Another disadvantage is that the homeowner builds equity at a snail’s pace. For a buyer looking to eventually move up to a larger home, this slow pace of equity accumulation is a liability.

Even with the very same rate on a 30-year as a 40-year mortgage savings are negligible. A $200,000 mortgage financed for 30 years at a fixed rate of 5.75% would carry a monthly payment of $1,167.15.

By stretching the loan term an additional 10 years, even at the identical interest rate, reduce the monthly payment by $100, to $1,065.78, the borrower also would have $16,389 less in equity at the end of the first decade of payments and would have paid an extra $4,200 in interest.

This all stems from affordability and borrowers stretching themselves beyond their reach to get into a home they can’t afford. What’s next, a 50-year loan? When housing cools, so will these 40-year loans.