40-Year Mortgage Loan - The Slow Route
If you are looking for a low payment mortgage loan, then a 40-year mortgage loan may be an option. Learn why it is a rare product (not all lenders offer it) and why it is appropriate for just a few borrowers.
While most borrowers prefer either a 30-year FRM or a 15-year FRM (Fixed Rate Mortgage) other products do exist including a 20-year FRM, interest only payment mortgage, balloon payment, or various ARM mortgages. The general rule is that the shorter the loan period is, the lower the interest rates will be; however, loans that have a grace period, interest only payments, or a balloon payment are priced differently.
Record low interest rates for FRM (Fixed Rate Mortgage) loans have been set in 2012. Just to give you an indication of what average industry interest rates are, according to the Freddie Mac weekly survey for the week of May 10, 2012 the national average for a 30-Yr FRM was 3.83% (0.7 fees and points) and a 5/1-Yr ARM was 2.81% (0.5 fees and points and margin of 2.74%).
There are reasons for taking a non-orthodox mortgage loan. In order to evaluate if a 40-year mortgage loan is best for you learn about the:
- Characteristics of a 40 year mortgage loan
- A comparison of monthly payments and interest costs
- Benefits, Risks and Alternatives for a 40-year mortgage loan
Characteristics of a 40 year mortgage loan
Mortgage loans come in different payment styles. Before you consider taking a 40-year mortgage here is a brief explanation of loan repayment terms other than the length of the loan.
Type of Interest Rate: Your interest rate terms are set when you take the loan and include:
- Fixed Rate: The most common one is a FRM in which your monthly payment never changes during the life of the loan. This is especially attractive if the interest rates are low.
- Variable Rate: The second type is an ARM (Adjustable Rate Mortgage) in which your interest rate is set for a specific period and then adjusts on a regular basis. A common ARM is a 7/1, in which the initial interest rate is set for a 7 year period, and then adjusts every 1 year. (Check for caps and ceilings on an ARM loan).
Payment terms of loan: Your loan may have a fixed payment, a variable payment due to interest rate fluctuations, or a specially structured payment such as an interest only period, or a balloon payment loan.
Many 40-year (and even 50-year) mortgage loans are a combination of a fixed rate and a balloon payment. The monthly payment is based on a 40-year payment schedule, but the loan terminates after 30 years. This allows a more affordable beginning payment, with no risk of change for the full 30-year period. In most cases, borrowers do not carry their loans to the end.
A Comparison of Monthly Payments
40-year mortgages are rare, and only marginally lower your monthly payment. The example below illustrates a payment schedule (using interest rates of 4.25% and 4% respectively) for a 40-year FRM versus a 30-year FRM for a $400,000 loan.
The monthly payment is only $175 less (or $44 per month for every $100,000). If you analyze the two loans over a 7 year period, then the 40-year loan has $10,018 more interest charges and you will owe 24,733 more. (You only paid about $14,000 more in payments).
Example of Monthly Payment and Pay off Schedule for $400,000 loan:
|30-Year FRM||40-Year FRM||Difference|
|Balance at end of 7 years||$344,238||$368,971||$24,733|
|Total Interest at end of 7 years||$104,649||$114,667||$10,018|
|Total Interest at end of loan||$344,238||$432,551||$148,073|
Note: Interest rates are for illustrative purposes only.
Benefits, Risks and Alternatives for a 40-Year Mortgage Loan
The main benefit of a 40-year mortgage is low beginning payments. This can be a good choice if you meet one of the following situations:
- Starting your career and have limited income, that you expect to increase.
- Want to move to an expensive area, for example for schooling reasons, and can’t afford high monthly payments.
- Planning to move in a few years, but want flexibility to keep mortgage payments fixed if you don’t move.
- Want the flexibility of low fixed required payments, with the opportunity to make lump sum or monthly-accelerated prepayments.
The risks of a-year mortgage are:
- Your budget calculations were off due to either lower income and/or higher monthly expenses than originally projected. Since you started with low payments, you really have no room to move if you need to change your payment schedule. If you moved into a higher priced area, or a larger house than you really could afford, then your other expenses may be higher than you originally planned.
- You need to sell the house because you need to move (job relocation, can’t afford payments) and your equity position has worsened. Many borrower plan on paying off loans by selling property at appreciated values. Therefore, they feel that they could enjoy both low monthly payments and make money on the sale. Unfortunately, housing prices also go down, and if you haven’t put equity in your property, you may not be able to pay off the loan from the proceeds of the sale.
Before looking into a low payment 40-year mortgage loan, I suggest that you carefully follow these steps:
- Use the mortgage affordability calculator to see how much you can afford based on your income, down payment and a 30-year FRM.
- Budget carefully your monthly expenses vs. your monthly income. Make sure that you are saving money in a rainy day fund, savings account and down payment funds.
- Look into a 7/1 ARM for a lower interest rate, with the initial interest rate locked into a 7 year period. Make sure that you have sufficient assets to deal with the risk of the payment change.