40-year mortgages join the mix

The 40-year mortgage, for years a niche product, has gone mainstream. Whether it earns widespread acceptance is another matter.

Forty-year mortgages have lower monthly payments than their 30-year cousins, although they cost more over the life of the loan because the borrower pays interest for 10 years longer. With the lower monthly payments, they are seen as a tool to allow people to buy homes that are unaffordable with 30-year mortgages.

"It allows you the opportunity to have a lesser payment, and for many people it gives the luxury of choice," says Jim Sahnger, a broker with Palm Beach Financial Network in Sewall's Point, Fla.

Forty-year mortgages have been rare because lenders couldn't sell the loans to investors through the government-sponsored enterprises Fannie Mae and Freddie Mac. The mortgages remained on the lenders' books, tying up money for a long time. That state of affairs changed in June 2005, when Fannie Mae started buying 40-year home loans.

For a long time, Fannie Mae would not buy mortgages with terms longer than 30 years. Fannie Mae stuck its toe in the 40-year mortgage pool a year and a half ago when it started a pilot program to buy the long loans from 22 credit unions. Now Fannie Mae has taken the plunge, and will buy conforming 40-year mortgages from any qualified lender.

Borrowers will have a choice of a fixed-rate loan or a variety of adjustable-rate mortgages, or ARMs. A spokesman for rival Freddie Mac says the company doesn't buy 40-year mortgages, but is considering adding them to its product line. However, spokesman Brad German adds, "Borrowers looking for lower monthly payments have plenty of other options to choose from, such as ARMs, interest-only loans or combinations of the two."

The demand for 40-year mortgages has been minuscule, partly because few lenders have offered them. The most-prominent 40-year lender is Washington Mutual. Fannie Mae assumes that more lenders and brokers will offer the long loans now that they can be sold on the secondary market.

It's not a sure bet that 40-year loans will catch on for at least three reasons. First, the interest rates are slightly higher -- usually an eighth to a quarter of a percentage point. Second, tacking 10 years onto the payment schedule doesn't save all that much money every month. Third, interest-only mortgages have exploded in popularity in the last two years, and they offer even lower initial monthly payments than 40-year loans.

Still, "I think a lot of people will take a look at it," Sahnger says of the 40-year mortgages. He believes that they will appeal to "the ones who are most likely on the edge of qualifying. They might be a first-time buyer or a move-up buyer."

They might attract borrowers who are on the edge of qualifying because of the lower payments. Generally, Fannie Mae doesn't want the monthly mortgage payment to exceed 28 percent of the borrower's monthly income and for all debt payments (including mortgage) to exceed 36 percent of income.

Some buyers might barely stray outside of those guidelines when applying for a 30-year mortgage -- for example, if the house payment would be 29 percent of monthly income. In such a case, a 40-year loan might allow the borrower to qualify by sliding under the 28-percent threshold. We're talking small differences, though: On a $200,000 loan, the monthly savings would amount to less than $64 on a 40-year, fixed-rate mortgage at 6.25 percent compared to a 30-year fixed at 6 percent. And the monthly savings shrink if interest rates rise.

Fannie Mae has been buying a small number of 40-year mortgages from credit unions since the fall of 2003, when it began testing the long loan. "We haven't seen a huge volume for the 40-year pilot (program), we think because interest rates remain low," says Sandy Cutts, a spokeswoman for Fannie Mae.

With interest rates expected to rise, and with property values soaring on the coasts, the 40-year loan might make homes affordable to a few more middle-income buyers, Cutts says."We don't in any way think the 40-year is going to eclipse the 30-year, but it does have its place and we think it's going to be appealing to some borrowers."

They will compete with interest-only mortgages. Those, too, were a niche product until home prices began zooming in parts of the country three or four years ago. Now interest-only loans occupy a big chunk of the mortgage market in high-price cities as buyers hunt desperately for ways to afford absurdly expensive houses.

Most interest-only loans are ARMs. Forty-year ARMs will have comparable interest rates to interest-only ARMs, but payments will be higher because the borrower pays principal in addition to interest.

Forty-year ARMs bought by Fannie Mae are hybrid adjustables with initial rates that last three, five, seven or 10 years, then adjust annually afterward. Borrowers can choose to have the loans indexed either to the LIBOR (London Interbank Offered Rate) or the CMT (constant maturity Treasury).