Many would-be homeowners are dropping out of the market due to the recent increase in interest rates. Yet others are looking at alternative financing in the hopes of being able to purchase a house today and reconsider their loan later. One option that has gained some popularity is the 40-year mortgage.
What it is
A 40-year mortgage is basically just what it sounds like – 30 years + ten. It’s a type of loan that offers borrowers extended time to pay off their homes. And just like a 30-year mortgage, you may find these offering fixed or adjustable rates. Some 40-year mortgages even offer a short-term interest-only payment period, bring the cost of home ownership even lower.
Can you find one
One major difference between a 30- and 40-year mortgage is the 40-year loan is an unqualified mortgage according to the Consumer Finance Protection Bureau. This means you may have a difficult time finding them. Many traditional banks don’t offer these because they consider them less safe than 30-year loans. Consider contacting credit bureaus and mortgage brokers possibly even before you start house hunting to ensure you can find one and live with the terms.
Lower payments
By extending the repayment period to 40 years, borrowers can spread out the principal amount over a longer time frame, resulting in lower monthly payments. This can be particularly beneficial for first-time home buyers or those on a tight budget as it allows for more financial flexibility. An example (using this website calculator): if you’re purchasing a home for $350,000 with 20% down at 7%, a 40-year mortgage would cost $1,740 per month; if you chose the 30-year mortgage, you would pay $123 more per month for a total of $1,863.
Free up money for other necessities
Some people are considering the 40-year mortgage just to be able to afford the house they want. Others are using it so they aren’t as house poor (meaning a large portion of their after-tax take home pay is going to the mortgage payment alone). With the lower payments, you can perhaps afford improvements to the home or even investment opportunities.
Pay more in interest
While you are taking advantage of lower payments, you are paying more in interest over the life of the loan. If you look at a 15-year mortgage, rates are normally lower than for a 30-year; similarly, a 30-year mortgage will provide interest rates that are lower than for 40 years. On top of the higher rate, you will be paying it for ten years longer if you make every payment and own the house for the duration. Using the same numbers from our example above, interest on the 30-year mortgage would equal approximately $391,000; but with the 40-year mortgage, you would pay $555,000. While only saving $123 per month, you would end up spending $164,000 more for the home over the life of the loan.
Takes longer to build equity
With a 40-year mortgage, it takes longer to build equity in the home as the principal payments will be spread over an extended period. If you don’t put 20% down, this slower equity build means it will take a longer time to reach the 20% threshold when you can remove private mortgage insurance. Plus, it can limit options for refinancing or accessing home equity loans for future financial needs.
Pay it off seemingly forever
Think about today’s first-time home purchasers for a moment. The millennial generation has often been ostracized because they were “late to the game” in home buying, starting families, etc. If you’re a 35-year-old first-time buyer, a 40-year mortgage means you’re still paying off your home well into retirement. One goal many people have is to pay off their mortgage to make retirement budgeting easier. This could limit your ability to retire when you want and your chance to enjoy it once you do.
Before deciding on a 40-year mortgage, educate yourself. Talk to mortgage brokers about the availability of these and also about other options. Perhaps using a three- or five-year adjustable rate mortgage will move the house of your dreams into the affordability zone. Also, look clearly at where you are and where you want to be. Could you be happier with a less expensive option that’s away from the city or that needs work? Or could you even save for another year so you have a larger down payment, allowing you to use more common mortgages? Perhaps you consider this house as the five-year home and redouble your efforts to save more for the next one.
Photo by Mika Baumeister