I’ve been seeing more ads lately for 40 year mortgage loans and once my curiosity was piqued, I also found that there are 50 year and 60 year mortgage loans out there. On one hand, I found this to be rather unorthodox and novel since you never hear about “40 year mortgage rates breaking new records”, etc. in the press – it’s always the 30 year conventional loan followed by the 15 year conventional. Conversely, the notion that these new longer duration mortgages would start to flourish in this environment is logical upon further consideration. Where there’s a will, there’s a way. Let me explain:
With the current underwriting scrutiny and backlash over the ridiculous lending practices that led to the recent housing bubble, it’s not as easy to qualify for a mortgage as it used to be. Now, you have to demonstrate the ability to pay your mortgage with actual income (what a concept!). For many people, even at today’s lower home prices, they can’t afford the payments on a conventional 30-year mortgage. While Interest-Only Adjustable Rate Mortgages are an option, with rates this low, I’d be remiss to lock into a record low rate now with the assumption that it isn’t going to jump substantially when the Fed eventually has to raise interest rates significantly in order to stave off inflation, taking mortgage rates with it (indirect correlation, not a direct relationship; these resets are based on LIBOR). Therefore, lenders and prospective homeowners alike are rushing to fill a vacuum. The vacuum is created by the removal of the old risky loans with the insertion of new longer duration, “more easily affordable” 40 year, 50 year and even 60 year mortgage loans. As outrageous as these longer term loans sound, let’s investigate the pros/cons a bit more – who said a 30 year mortgage was right? That sounds long to me as well. It also seems short to me given life expectancy in the US. It’s all a matter of perspective.
Benefits of a 40 year, 50 year or 60 year mortgage:
- Longer duration = Lower Payment – Similar to the difference between the common 30 year and 15 year conventional mortgages, by extending your mortgage term out, your monthly payment drops accordingly.
- Flexibility - While you may start with a 40 year mortgage, you could easily turn that into a 30 or even less by employing any of the common ways to reduce your mortgage term like making bi-weekly payments, making one extra payment per year, etc. The rationale here would be to start off early with a lower payment based on your ability to pay and as your income grows while the mortgage payment remains roughly fixed (nominal increases for tax and homeowners annually), it would be easier to make the additional payments in the future or flat out refi into say, a 15 year down the road.
- More House for your Money - While this is the mindset that got so many Americans into trouble to begin with, let’s face it, we want what other people have. You see the neighbor down the road who doesn’t make as much money but has the new car and bigger home. You have a family member you’re jealous of because they have more “stuff”. People want to push the limit of what they can afford, and often exceed that limit with our various generous debt instruments. As such, a 40, 50 or 60 year mortgage allows one to have much more house than they’d normally be able to afford in a conventional 30 year mortgage.
- Example 40 Year Mortgage Calculator - If you have a $300,000 loan with a conventional 30 year mortgage vs. a 40 year mortgage, even though you’ll pay say, .25% higher in the 40 year mortgage, your monthly payments will be about $100 less per month. That doesn’t seem like much, but this might put you either in or out of your debt/income ratio to afford the house of your dreams. Use Quicken Loans to see what lenders in your area are willing to offer you on various mortgage terms. I began my search for the best refi deal on the internet in similar fashion – comparison shopping!
Risks of a 40 year, 50 year or 60 year mortgage:
- 40 year mortgage rates are higher than conventional 30 year rates. It’s worse for 50 and 60 year mortgages. This is logical, as you’ve probably noticed that 15 year rates are lower than the 30.
- You’ll Likely Never Own your Home – Let’s be realistic here on the 60 year mortgage especially. Since it’s unrealistic to start a mortgage until in 20s and life expectancy is 78 (according to wikipedia, we’re #45 in the World – pretty bad for a “superpower”), for those extending the full term, they may never live to see the day they own their home outright. Consider it renting, but with a minimal tax deduction in the tail end years. Put another way, you’ll build equity in your home at a much slower rate due to the way mortgage loan amortization works – primarily interest up front and slow equity build which eventually translates into a higher equity build and lower interest payments at the tail end of a loan, which for 40 year mortgages and beyond, is very much further out than conventional options.
- Much More Interest Paid Over Time - This is true. You’ll pay what appears to be a huge number more in interest over time. However, I think the “interest over time” argument is often over-hyped, especially by these outfits advocating for you to save all this money by pre-paying your mortgage (see this criticism of UFirst Financial’s Money Merge Account). What it really comes down to is Net Present Value. There’s a current value of money and a future value of money. Once you understand what your cost of cash is and what your interest rate is, the spread is what you’re paying out of pocket across a day, a year, or 40 years. It’s all about NPV (see this NPV explanation and model with respect to determining your optimal mortgage to select).
My Take on 40 Year Mortgage Loans and beyond
I have mixed feelings on these longer duration mortgages. While I think the 50 and 60 year mortgages are pushing lunacy, the 40 year mortgage loan may not be the worst investment for a 20-something looking to get started and maintain a cash cushion with the extra money they’re saving each month. I know people are going to attack me for saying it, but is it really any different than people starting out with an Interest-Only loan and then refinancing into a conventional 30 year mortgage at some point in the future? After all, in the early part of the loan, you’re barely paying down any equity anyway. In this case, at least the 40 year mortgage loan involves some equity paydown early on right? Like I said below, various options present themselves to this homeowner. Five years into the loan, perhaps due to a changed financial situation, the homeowner can now either start making a few voluntary payments along the way to bring it down to a 25 or 3o, or they could simply refinance into a new loan later (assuming rates are attractive).
Conversely, my vacuum argument holds that while there may be 10% of the population who utilize the loan in a prudent manner in which I outlined above, we’ll have another 90% of the population who rely on 50 and 60 year loans to fund real estate that they couldn’t afford. What’s next, rather than the sub-prime meltdown, we’re going to have the 50-year loan meltdown bailout?
An argument I won’t use: Businesses enter into 99 year leases all the time in the likes of Singapore, Dubai, etc. If you can’t own the land, you enter into a lease that’s practically long enough that the business will be completely morphed by the time the lease is up. Whoever signed that initial lease deal will be gone anyway, right? Let’s not confuse a business deal like this with the place you have to live and possibly rely on as part of your nest egg.
What Would You Tell Someone Looking to Get Into a 40 Year Mortgage or Longer?
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