Pros and Cons of a 40-Year Mortgage

A Payment-Lowering Alternative Mortgage

Pros and Cons of a 40-Year Mortgage
November 21, 2014

Most mortgage terms are for 15 and 30 years, but you may be able to secure a 40-year mortgage through some lenders. The main purpose of this mortgage is to stretch out the loan term to produce a lower monthly payment.

Some other advantages of a 40-year mortgage are:

  • Affordability – When interest rates are higher, a 40-year mortgage may be the only way you can qualify for a relatively large mortgage.

    With a lower monthly payment, you may be able to purchase a more expensive house than you normally would have with a 30-year loan – although based on people’s experiences during the housing boom and bust, this is arguably as much of a con as a pro.

    An alternate, and more useful, version of this is to extend the term to lower monthly payments on a house you can already afford, and pay extra toward the principal to cut into the compounding of interest. Verify that the loan allows for extra payments toward principal, and use an online mortgage calculator to verify that the interest savings are preferable to a traditional 30-year loan with a slightly lower interest rate.

  • Fixed Rates – 40-year mortgages are almost exclusively fixed-rates. Given the extremely low interest rates available today, a low fixed rate lasting for 40 years can eliminate the need to refinance. To reap the benefits, you need to stay in the home for a significant portion of the loan term.

  • Mortgage Interest – For those with high-income, there may be tax benefits to having more mortgage interest to write off. However, that is a bit of making lemonade out of lemons.

There are also a significant number of disadvantages, such as:

  • Interest Rates – Banks charge slightly higher interest rates for 40-year mortgages to cover the perceived increased risk, since homeowners usually choose 40-year mortgages specifically because they are stretching their budgets.

  • Total Interest – With an extended loan term and a higher interest rate compared to a 30-year loan, the total payment amount increases significantly for a limited return on lower payments.

    Using our Home Purchase Fixed Rate Mortgage Calculator gives a fine example of why the above topics matter. For a 30-year fixed-rate 5% loan of $100,000, monthly payments are $536 with total payments of $192,960. Extend that to 40 years and the monthly payment drops to $482 with total payments of $231,360; you would be paying almost $40,000 extra over the life of the loan to save $54 per month.

    Unfortunately, your interest rate will most likely be higher for a 40-year loan as well. A 5.25% rate in this example would make the monthly payment on a 40-year mortgage $499 and the total $239,520. By switching to a 40-year mortgage at 5.25% from a 30-year mortgage at 5%, you are only saving $37 per month but paying more than $46,000 over the life of the loan for that privilege.

  • Slow Build of Equity – The downside of having lower payments is that it will take a longer time to build equity in your home. However, you can make extra payments toward the principal to blunt this effect. However, if that were easy, would you be asking for such a long loan term in the first place?

  • Limited Short-Term Options – If you have to sell your home for any reason (for example, relocation for a job) or need to refinance, you have lost most of the advantage associated with a 40-year mortgage.

Standard 15 and 30-year mortgages are suitable for most homebuyers. However, if you need to stretch your budget to afford a home, a 40-year mortgage is a good way to do it. Just look over your other housing options first, and make sure you maintain the financial discipline to make all of your payments with a pre-stretched budget.

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Jim | 06.13.16 @ 09:47
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