Pros and Cons: The 40-year Mortgage
As consumers evaluate the prices in today's real estate market, they're looking for traditional as well as alternative strategies to help them get into a home. One way to combat a challenging price tag is to apply an old strategy – the 40-year-mortgage – to current financing options. Not all lenders are offering a 40-year mortgage, but they're worth exploring.
How a 40-year Mortgage Works
As with today's more common 15, 20 and 30-year conventional mortgages, the amortization period of a four-decade mortgage is pegged to a fixed rate. Lenders can add a ten-year extension to a 30-year mortgage to help spread out and thus lower payments for consumers. There are lenders that also offer adjustable-rate mortgages (ARM) with a 40-year long repayment periods.
The Pros of a 40-year Mortgage
Mortgages with long terms can be especially attractive to people trying to rein in their monthly spending over a long period. The interest rates go up slightly on a long term mortgage, but lengthening out the repayment period and reducing the monthly out-go can make all the difference in whether the family can afford to own a home.
For example, a homeowner facing a $200,000 mortgage would pay out $955 per month with a 4.0 percent 30-year loan. The same monthly payment on the home would drop to $851 per month, financed through a 40-year loan at 4.125 percent interest. The $104 per month saved can allow a family to qualify for a home (or a better home), free up cash for investing or help them pay off other debts. Buying a better property -- skipping the "starter home" phase -- lets people avoid the expenses and hassles of selling, buying again and moving.
On the Downside
The total amount of interest due on a long-term mortgage can be staggering – if you had to pay it all back at once! The total interest paid with the 40-year loan is $208,708 -- about $65,000 more than that of the 30-year loan.
Another concern: Equity builds slower than homes financed under the terms for a 30-year mortgage on the same property. This can be a serious drawback for consumers who need to sell the property -- they may not have enough equity to cover the costs of selling, especially if the market is not strong.
Those who need monthly cash relief like first-time buyers may find that the 40-year mortgage is a good way to start. Remember, few homeowners ride out the length of their first mortgage. After enjoying the monthly payment rate a few years and raising their earnings, long-term mortgage holders can refinance to a shorter term. Investors with higher incomes may also choose this long-term mortgage if they use the property as their sole major tax deduction. A long-term mortgage can also aid in reducing rental property carrying costs. An interest-only mortgage, regular or hybrid ARM are other financing options for buyers who need to constrain monthly payments. The drawbacks include no equity-building performance with an interest-only loan or in the rising rates that can be applied to ARMs.