lower payments, slower equity
Rapidly rising home prices could increase
the popularity of 40-year mortgages.
For a given amount, a 40-year
mortgage carries lower monthly payments than a 30-year home loan. That means a
40-year mortgage allows you to afford a slightly more expensive house. The longer
loan term has disadvantages: You pay more interest and build equity slower.
have existed for a few years and have gradually grown in popularity. Not all lenders
offer them, and lenders structure the loans in different ways. A few lenders offer
40-year fixed-rate loans, just as they offer 15-year and 30-year fixed-rate mortgages.
More commonly, lenders offer a 40-year amortization on adjustable-rate mortgages,
or ARMs. A customer might get a 5/1 ARM with five years of fixed payments and
35 years of annual rate adjustments thereafter.
room for more house
No matter how the loan is structured, the
benefit to the borrower remains the same: lower monthly payments.
Nationwide, the median resale prices of single-family homes increased 8 percent
from the first quarter of 2001 to the first quarter of 2002. In Mobile, Ala.;
Worcester, Mass., and Long Island, year-over-year home prices jumped more than
20 percent. In places with rapidly rising values, some home buyers will try 40-year
mortgages before they are completely priced out of the housing market.
Astoria Federal Savings, a Long Island-based thrift, offers adjustable-rate mortgages
amortized over 40 years. The longer-term mortgages are useful in an era of rapid
increases in home values, says Gary McCann, senior vice president of Astoria.
"They can buy a little more house," he says. "It's more affordable
and they can stretch their payments out a little more."
Here's how: Let's say you can afford to pay $1,750 a month for principal and interest,
excluding taxes and insurance, and that you can get either a 30-year or a 40-year
mortgage at 7 percent interest. (That would be a high rate in the middle of 2002,
but a low rate in most years.) With the 30-year loan, you can afford to borrow
a maximum of $263,044. With a 40-year loan, you can afford to borrow up to $281,610.
The 40-year loan allows you to borrow more than $18,000 more.
Slow equity loan
You pay huge buckage
for the privilege of taking out that 40-year loan for a slightly larger amount,
though: $191,426 more. That's how much more interest you would pay over the life
of the 40-year loan in the example above -- partly because you're borrowing a
little more, but mostly because you're paying interest for 40 years instead of
That objection to 40-year mortgages has a flaw:
Most mortgages are paid off early, anyway, when the borrower refinances the loan
or sells the home. Hardly anyone is going to make payments on the same mortgage
for 40 years.
Another drawback to a 40-year mortgage: You
build equity more slowly. With that 40-year loan in the example above, you would
pay $107.29 in principal the first month. With the 30-year loan, you would pay
$215.61 in principal the first month -- building equity quicker on a slightly
smaller loan amount.
Although borrowers can use 40-year mortgages
to squeeze into more expensive houses, that's not a great reason to get one.
"I would not recommend that anyone use a 40-year
amortization to be able to afford more home than under a 30-year loan," says
Daniel Roe, a certified financial planner and principal with Budros & Ruhlin
financial advisers in Columbus, Ohio. "The best plan is to figure out what
you can comfortably afford and then structure the mortgage that is best, given
your overall goals."
This advice comes from a guy who had a 40-year loan on
a previous mortgage. He didn't get a 40-year mortgage to buy more house than he
could afford otherwise; he took out the longer loan so he could invest the difference
between the payments on a 30-year loan and a 40-year loan.
took the 40 and immediately bumped my monthly savings into my portfolio by that
amount," Roe says. "The strategy should be used by disciplined savers
to build equity outside of their personal residence. If you can invest the monthly
difference over the long term at a rate greater than your mortgage rate, then
you will build more wealth."
McCann, of Astoria
Federal Savings, agrees that savvy investors can use 40-year mortgages to contribute
more money to their portfolios. On the other hand, he thinks it can be wise, under
some circumstances, to use a 40-year mortgage to buy a home that would be unaffordable
with a 30-year loan.
"Some people are looking to
just get in there initially and get established, get on their feet, and more than
likely in the next five or seven years, they'll be refinancing anyhow," he
McCann likens 40-year mortgages to interest-only
mortgages. Both are sometimes used by people who expect a big pay increase
in the next few years, or who plan to own their houses for a fairly short time
and feel confident that sale prices will appreciate.