The New 40-Year Mortgage
The idea of the 40-year mortgage has been around in America since the 1980s, when interest rates reached record highs of over 18%. With those massive interest rates, the affordability of monthly mortgage payments was a big problem. Increasing the terms of the mortgage to 40 years rather than 30 lowered monthly payments, making mortgages affordable for more people.
Even so, this type of mortgage didn't achieve much popularity until 2005, when Fannie Mae announced a pilot program to test-market a 40- year mortgage in America. In 2006, with housing affordability becoming an issue once again, approximately 5% of new mortgages are 40-year fixed-rate mortgages.
40-year mortgages offer lower monthly repayments for those who can't afford a 30 year mortgage. For example, a loan of $100,000 at 8.5% for 30 years will mean monthly repayments of $769. Financing the same purchase with a 40 year loan would mean monthly repayments of $733. It may not seem like a lot, but for a family with a tight budget, it can mean the difference between continuing to rent, and being able to own their own home.
What Are the Disadvantages of a 40-Year Mortgage?
While monthly repayments are lower on a 40-year mortgage, over the life of the loan, you'll end up paying significantly more in interest than you would with a 30 year loan. Taking that $100,000 loan as an example, with an 8.5% interest rate, the cost of borrowing for 30 years is $276,840. With a 40-year loan, the figure jumps up to $351,840 - which means that 40-year loan is costing you $75,000 more than a 30-year loan would. And it's not even that simple. 40-year loans usually carry a higher interest rate than 30-year loans, because the extended term means that lenders carry more risk.
Another significant problem with the 40-year mortgage is that building equity in the property takes a lot longer. Mortgages are front-loaded in terms of paying interest, and payments on a 40-year loan are almost all interest at the start. And because it takes longer to build equity, it means your costs are higher - for example, if you have private mortgage insurance, you'll be paying it for a lot longer than with a 30-year loan, because you must pay the insurance until you have at least 20% equity in the property.
And if housing prices go down, you're at even greater risk. Suddenly, you owe more than the house is worth, and you've got too little equity in the house to make refinancing a good option.
In short, a 40-year loan may not be the best idea, unless you're planning to refinance or move within five to seven years. If you can't afford a 30-year mortgage, in some circumstances it might be better to continue renting and save for a larger down-payment to reduce interest, rather than going for a mortgage with a longer term.
Republished with Permission from HomePages.com
© 2008, HouseValues Inc.