September 24, 2012

40-Year Mortgages

Although they’re fairly uncommon, compared to more conventional loans like 30- and 15-yearfixed-rate mortgages, 40-year home loans are offered by most major lenders. They’re also a popular option in loan modifications, when the term of a loan needs to be extended as long as possible to minimize a homeowner’s monthly payments.

Minimizing your monthly payments, of course, is the key feature of a 40-year mortgage. As the longest term available on a home loan, it allows you to stretch out your payments and reduce what you pay in principal each month, so you’re getting the smallest possible monthly payment.

The downside is that you end up paying a lot more in interest over the life of the loan, which is why many financial advisors tend to recommend against 40-year mortgages. But for some borrowers, they can be a sensible choice.

The first question is, how much can you save? Perhaps not as much as you think. On a $200,000mortgage, your monthly payments with a 40-year fixed-rate mortgage may be about $90 a month lower than a comparable 30-year loan, depending on the interest rate you get.

Part of that is because you’re likely to pay a higher interest rate on a 40-year mortgage than you will on a 30-year loan. Typically, the interest rate on a 40-year fixed-rate mortgage will run about a quarter of a percentage point higher than a comparable 30-year loan. So if the current 30-year rateis 3.75 percent, you’ll pay about 4.0 percent for a 40-year mortgage.

Using those numbers, the monthly payment on a $200,000 mortgage would be $926 with a 30-year loan, and $836 with the 40-year mortgage. Of course, escrows for taxes, homeowner’s insuranceand perhaps private mortgage insurance (PMI) would add a few hundred dollars to this.

Stretching out those payments for an extra 10 years means you’ll really get hit with the interestpayments, though. In the examples above, you’d end up paying $133,000 in total interest over the lifetime of the 30-year mortgage, versus $201,000 over the life of the 40-year mortgage – more than the principal of the loan itself.

You also build equity much more slowly with a 40-year mortgage than a 30-year loan. Again, using the examples above, you’d have half the principal on the 30-year loan paid off after 19 years. With the 40-year loan, it would take about 27 years.

So why consider a 40-year mortgage? Well, for one thing, mortgage interest is tax-deductable for most homeowners, so the actual cost in interest isn’t as great as the figures would suggest. Deducting mortgage interest is also puts many homeowners over the threshold of being able to itemize other deductions as well, instead of taking the standard deduction.

A 40-year mortgage also provides budget flexibility. Just because your mortgage has a 40-yearterm doesn’t mean you have to take 40 years to pay it off. If you take out a 40-year mortgage but make the same payments that a 30-year loan would require, you can pay your mortgage off on a 30-year schedule and with 30-year interest costs, while preserving the ability to make smaller payments occasionally if needed.

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