Resist the siren song of 40-year mortgages

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Due to rising interest rates and rising home values, the monthly mortgage payment for a typical US home is 62% higher than a year ago. It is therefore natural to look for a way to reduce costs. But if you’re borrowing money to buy a house and think the answer to a cheaper mortgage is a longer-term loan, like 40 years, think again.

The idea seems simple enough – just extend the term of the loan to save on monthly payments and refinance as soon as rates drop enough to make it worthwhile. Also, a 30-year mortgage is a bit of a misnomer because no one really keeps the same mortgage for three decades these days. So why not go there for 40 years? There are many reasons not to play with terms.

First, the monthly savings are unlikely to be substantial. If you borrow $300,000 over 30 years at a fixed rate of 5% for the life of the loan, your monthly payment will be about $1,610, according to calculations by HSH.com, a consumer mortgage website. . Assuming the same rate for a 40-year fixed mortgage (which is generous since 40-year mortgage rates are likely to be higher), the monthly payment will be around $1,447, a savings of $163.

Of course, every little bit counts at a time when housing affordability is at its lowest in decades, meaning the median household income is below what is needed to qualify for a mortgage to buy the house at the median price. But that’s not the case when you factor in the extra interest you’ll pay. In just five years, you’ll have paid about $3,700 more in interest on a 40-year loan than on a 30-year loan, and you’ll owe about $11,000 more because less of your payment on 40 years will go towards the principal amount borrowed. And if you end up holding the loan for 40 years, you’ll pay $115,000 more in total interest than if you had taken the 30-year loan.

And that’s why some lenders will be happy to give you a 40-year loan if you ask. They would like to take advantage of another product that could apparently make a home more affordable, as it would help generate additional income. This is especially true now that mortgage activity has fallen this year.

It’s not like you can borrow a lot more with a 40-year loan. Assuming an income of $150,000 and all else being equal, a longer-term loan increases the amount you can borrow by about $40,000, according to the HSH Calculator.

Perhaps the biggest red flag with a 40-year mortgage is how slowly you will increase the equity in your home, as more of your payment goes to interest than principal compared to a mortgage. shorter term. This could become an even bigger problem if house prices continue to slow or even fall as we enter a housing recession.

Remember that you generally need to have 20% of the equity in your home before you can refinance at a lower rate or adjust the term of your mortgage. Most people deposit much less than 20% and may not be able to reach that threshold as quickly as they thought with 40 years.

If you’re worried your monthly payment might be too high, there are other ways to lower the cost, like paying points to lower the rate, making a larger down payment, or even considering an adjustable rate mortgage. Ultimately, though, if $200 a month makes or breaks your ability to buy a home, you should probably reconsider.

Currently, 40-year mortgages are not guaranteed by Fannie Mae or Freddie Mac. This means that they are not guaranteed to have the same consumer protections as conforming loans, such as a limit on excessive charges. Since you’ll have to go to an online lender, or a smaller bank or credit union to get one, the rate may not be as competitive.

Earlier this year, the Federal Housing Administration, which backs loans for first-time buyers, said struggling homeowners could change their existing home loans to loans with a 40-year term. (Fannie Mae and Freddie Mac also have an option to change existing loans to a 40-year repayment plan). Some saw this as a sign that the federal government might decide to support lending given how unaffordable homeownership has become.

Extending the term of the loan to 40 years might be useful for someone whose alternative is to lose their house, but given the mountain of interest and the slower pace of equity building, I don’t see why approving a 40-year mortgage for new owners would be a positive move for anyone other than the banks.

More other writers at Bloomberg Opinion:

• Will housing prices simply flatten or collapse? :Jonathan Levin

• Fed damage to housing market may have lasted for years: Allison Schrager

• Andreessen’s housing NIMBYism loses ground: Virginia Postrel

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.

More stories like this are available at bloomberg.com/opinion

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