The 40 Year Mortgage

In the past several years the mortgage market has seen a slew of new home loan products come and go.  One mortgage loan product that was first lobbed into the fray by sub prime lenders was a 40-year term mortgage.  Now that sub prime is tapering off, this term is being used on mainstream loan products.  The advantage of the 40-year term mortgage is to make the monthly payments smaller and housing more affordable.  While 40-year mortgages increase affordability by reducing the mortgage payment, the reduction is very modest.

Undeniably, the monthly mortgage payment on a 40 year term loan versus that of a 30 year term will be lower and subsequently allow some borrowers who would not normally qualify for a home loan be able to afford one.  However, the effect of extending the term of a mortgage payment is smaller the longer the initial term is set at.  This means that a change from 20-year term to a 30-year term can have a sizeable percentage change in the monthly mortgage payment.  The change from a 30-year term to a 40-year term is not nearly the equivalent drop in relative payment amounts.  For example, a 20-year mortgage for $250,000.00 at 6.0% has a principal and interest payment of $1791.08.  If this same mortgage loan is placed on a 30 year term the payment drops to $1498.88 or 16%.  This same mortgage loan amortized on a 40 year term would have a payment of $1375.53, a reduction $123.35 or only 8%.

Furthermore, the total payments on a 30-year term mortgage for $250,000.00 at 6% would be $535,595.47.  The added 10 years on the same home loan amortized over 40 years yields a total payback of $660,256.37.  The additional monthly payments add $120,660.90 in total charges for just a 6% reduction in the monthly mortgage payment. 

Lastly, we have to factor in different interest mortgage rates.  As a rule, mortgage loans do not last more than three to five years.  Homeowners generally refinance or sell their homes long before their home loan term is due.  Even though the average home loan does not last anywhere near their original terms, mortgage lenders will charge a higher mortgage rate for the longer term home loans.  Fifteen-year term mortgages are usually about 1/4% lower in rate than a comparable 30-year tem mortgage.  The extension to 40 year leads to roughly the same increase of about a 1/4 % from a comparable 30-year term.  Having already calculated that the value of the 40-year term is fairly small, what limited monthly savings did exist is partially eroded with the higher mortgage rate.

The 40-year mortgage has a practical purpose of allowing a small segment of borrowers the ability to afford a larger home loan.  The disadvantage of significantly larger repayment and a slow down in equity build up, almost completely erases the benefit this mortgage loan would have for most all borrowers.  Before choosing the term on a home loan, whether it is for 15, 30 or 40 year term, home loan applicants should carefully review their budget and check the monthly payment on different mortgage loan terms with the appropriate mortgage rate.  The mortgage calculator is a helpful tool for quickly comparing the different costs, the different monthly mortgage payments, the mortgage rates and the total costs over the expected life of the home loan.