Amid record home prices and economic uncertainty, some buyers are exploring unconventional paths to homeownership, including one many people have never heard of: the 40-year mortgage. (Yes, it’s a thing.)
This blog will address how this loan term works, who can benefit from it and where to find it. We’ll also explore some pros and cons of a 40-year mortgage and how it compares to a 30-year mortgage.
Why have I never heard of a 40-year mortgage?
Although these loan terms are nothing new, many people don’t know about 40-year mortgages because most major lenders do not offer them. The Consumer Financial Protection Bureau (CFPB), which has supervisory authority over lenders, considers 40-year loans too risky to endorse as a Qualified Mortgage (QM). Without this designation, a loan is considered less saleable, which can make these mortgages harder to find.
How does a 40-year mortgage work?
Not to be confused with a 40-year mortgage modification, which extends the term of an existing loan up to 40 years, a 40-year mortgage is a new loan that gives buyers 40 years from the time of purchase to finance their home. Options for 40-year mortgages can carry different terms, with some incorporating fixed interest rates and others adjustable interest rates. Here is an overview of common loan structures:
1. Fixed-Rate Mortgage (FRM). The 40-year fixed-rate mortgage is a lot like the traditional 30-year fixed rate mortgage, just 10 years longer. Borrowers lock in a mortgage interest rate at the time of purchase for a period of 40 years.
2. Adjustable-Rate Mortgage (ARM). In this structure, borrowers start with a low, fixed mortgage interest rate before moving to a variable mortgage interest rate. The name of the loan product tells you how long the initial rate period lasts and how often the rate resets over the life of the loan. For example, a 5/5 ARM means the loan has a fixed rate for five years, then a new, variable rate every five years.
3. Hybrid ARM. This loan structure is an ARM with additional features. It starts with an interest-only period (usually five to 10 years) that makes monthly mortgage payments very low. Once it ends, the loan defaults to a FRM or ARM structure and requires borrowers to start making interest and principal balance payments. This results in higher – sometimes much higher – monthly mortgage payments. Some loans also require borrowers to make balloon payments, or large, lump sum payments.
What are some of the pros and cons of a 40-year mortgage?
A 40-year mortgage comes with several benefits and many drawbacks compared to a traditional, fixed-rate 30-year mortgage.
- 10 more years to pay off the loan.
- Monthly mortgage payments should be lower.
- Both 30-year and 40-year FRMs give borrowers predictable mortgage payments over the life of the loan
- A 40-year ARM structure can help borrowers qualify for a larger loan. It also gives them the flexibility to use their savings in other ways, like pay down high-interest debts or furnish their new home.
- Higher closing costs. Non-QM loans may have no limits on points and fees, so these could run much higher.
- Higher interest rates and total cost. Lenders add premiums to their base mortgage rates based on factors like terms and risks. Each added premium increases the interest rate and ultimately the amount of interest the borrower pays over the life of the loan. Borrowers of a 40-year mortgage can pay tens of thousands more dollars in interest than they would on a 30-year mortgage.
- Fluctuating rates. ARMs make budgeting more difficult because mortgage interest rates are tied to a financial index that changes. If the market rate goes up, so does the mortgage payment.
- Risk of negative amortization. During interest-only periods, borrowers may be required to pay less than the monthly interest that accrues on their loan. When this happens, the unpaid interest rolls into the principal loan balance, causing the borrower's debt to keep growing.
- Delayed equity. One of the biggest benefits of homeownership is the ability to build wealth through home equity. This happens when homes appreciate in value and borrowers pay down the principal balance on their loan. When borrowers are not required to do the latter during an interest-only period, it can take them longer to build equity they can convert into cash.
- Risk of default. If borrowers aren't paying attention to when the interest-only period ends or how their interest rate changes, they could be unprepared to make their new mortgage payment. What's more, if their financial picture changed negatively since the loan originated, it can be difficult to refinance for a better rate, which puts them at risk for defaulting on the loan.
Where can I get a 40-year mortgage?
Although most major banks shy away from 40-year mortgages, it never hurts to inquire. The safe bet is to research alternative lenders, like:
- Online lenders
- Private lenders
- Mortgage brokers
- Local banks
- Credit unions
It's also worth noting that there are currently no federally backed or Government Sponsored Enterprise (GSE) mortgage programs with a 40-year term.
Is a 40-year mortgage right for me?
It depends on your situation. It can help buyers on a tight budget in the short term, but it can also hurt those who fail to budget for higher costs down the road. Keep in mind that a 40-year mortgage is not the only way for buyers to lower monthly mortgage payments or increase buying power. Click here for alternative strategies to achieve these goals.
Choosing the type and length of mortgage you use to finance your home is a big decision, so it should not be made lightly. It's important to do your research, find a credible lender and weigh your options carefully. Whatever path to homeownership you choose, Old Republic Title will be here to help you protect your investment for years to come. For more information, contact an Old Republic Title representative today.
This material is for educational purposes only and does not constitute legal advice. Old Republic Title strongly recommends that consumers obtain guidance and advice from qualified professionals, including attorneys specializing in real property law or tax law to get more detailed and current information as to their particular situation.