Are 40-Year Mortgages Worth It? Here Are The Pros And Cons
A 40-year mortgage is a specialty lending product that some homebuyers have begun to consider alongside other more mainstream borrowing options. The 40-year term extends the payments out over a longer duration than any other mortgage loan term, with 30-year mortgages being the most common (at 90% of all mortgages funded), according to Mortgage Professional America Magazine.
30-year options provide borrowers with a long enough timeline to take advantage of minimal monthly payments, although they increase the total owed over 15- or 20-year mortgage terms with the addition of these extra years of interest buildup. The same tradeoff is present with the 40-year option. Borrowers considering these terms will need to think hard about what the benefits and drawbacks mean for their finances both long and short term.
In the present, borrowers can take advantage of much lower monthly payments (on average), according to Rocket Mortgage. The elongated timeline means that the total amount borrowed (plus interest additions, of course) are paid back over a timeline that's 120 pay dates longer than the standard 30-year mortgage. On the surface, if you're taking out a loan balance that falls just under the jumbo mortgage loan designation (typically at $647,200) — and not considering the added interest — you'll pay back $1,797.80 per month in principal on a 30-year mortgage, but only $1,348.30 per month if extended over a 40-year term. When adding in interest, the potential benefit can shift significantly, though.
Pro: Longer payback duration means lower monthly payments
Perhaps the most obvious benefit of a longer duration is the minimized monthly payments that you'll be responsible for, as noted by Rocket Mortgage. The longer your loan term, the less you'll pay each month, generally. With added years of repayment, you can alter the financial calculation that is necessary to make all your expenses fit together in a way that makes sense.
This is great for families with young children (who may increase the volatility of each month's outgoing needs), and for those who want to minimize their total owed each month in order to overpay on the debt throughout the duration of the loan. Overpaying on debts is a great way to quickly reduce the principal balance, and it can be an immensely helpful approach for homeowners seeking to reduce their total mortgage bill. It's crucial to check with your lender about the terms regarding overpayment though (via Nerd Wallet). Some mortgage products won't allow for overpayment or faster payoff strategies, and others will cap the amount you can jump ahead by.
Likewise, it's a good idea to consistently update your overall financial math to ensure that faster repayment remains a good idea for your changing circumstances. Life can shift quickly, and having the ability to overpay is great, but it also provides the ability to reduce your contribution back to the minimum required when necessary.
Con: The longer duration equates to more in tacked on interest
Alongside lower monthly payments comes the drawback of larger principal balance that sits on your ledger for a longer period of time. The longer your loan term is, the more you'll pay in interest; it's that simple. The ability to enjoy smaller monthly payments comes with this significant tradeoff, and it's essential to understand the increased weight of interest additions before finalizing the terms of any loan.
Rocket Mortgage reminds borrowers that loan amortization plays a significant role in the calculation of where your monthly payments are directed. Even if you enjoy a relatively small interest rate on the borrowed cash, your early payments are funneled toward interest repayment in a larger volume than those that will occur later in the life of the loan. This practice is common with all types of home loans, and it can be particularly painful for borrowers taking out loans of a longer duration than is typical. With a 40-year loan, the weight of interest additions is higher, meaning that more of your payment balance will be directed toward interest maintenance than is typical, as well.
Pro: 40-year mortgages can have an ARM arrangement attached to the terms
ARMs, or adjustable rate mortgages are a great benefit for borrowers who are timing the market for a longer-horizon interest rate crash. ARMs typically include a fixed rate term upfront, often around seven years in length, and then revert to a variable rate after the period expires.
With the ARM arrangement on a 40-year loan, you can take advantage of the deflated fixed rate offering that sits lower than variable rate marks across any market conditions. This also gives you a long term period of equal payments across the first few years of your mortgage loan.
Investopedia notes that and adjustable rate mortgage loan is great for those who are planning on a refinancing opportunity down the line. Locking in a rate upfront that allows you to overpay on the monthly bill can give you more leverage when it comes to refinance the remaining balance. You'll build credit and equity in the property, and with the addition of a 40-year term rather than one that's significantly shorter, you'll enjoy the ability to fall back on minimized monthly payments in the event of a lean month or dramatic change in your household's income (due to illness, lost jobs, or any other curveball that may come your way).
Con: 40-year loans can carry a higher interest rate
Along with other factors that find their way into the calculation of the interest rate that a lender offers you, the duration of the loan can alter this figure significantly. Bankrate notes that a 40-year mortgage will likely come with an inflated interest rate over the more traditional 30-year option. This is because of the unorthodox nature of the mortgage product, to be sure, but also because of the way that mortgage loans are treated within the financial marketplace.
Typical mortgages are sold to governmental agencies that secure the debt and bundle numerous fiscal products together. But the relative novelty of the 40-year offering makes it something of a misnomer when it comes to grouping mortgage loans.
Rocket Mortgage notes that qualified mortgages cannot hold loan durations exceeding 30 years, further separating these lending products from the more mainstream segment of the marketplace. All this adds up to a more complex loan that may be offered as an option designed to reduce your monthly contributions, but this benefit is paid for, in a way, in other areas of the agreement.
The bottom line
The bottom line is that shopping around for mortgage products is a complicated process. A 40-year mortgage may be the perfect financial tool for your unique needs, or it may present a set of problems that can be difficult to remedy down the line.
MarketWatch reports that a 40-year loan can offer a good monthly payment reduction, but it may not be as substantial as you'd have hoped. Still, during the purchase of a home, it's worthwhile to explore all the options available to you—including more unorthodox financing opportunities.
Smaller minimum payments, even those reduced by a few hundred dollars a month, can act as a powerful swing in the right direction for your finances. For those who are on track for a big promotion for instance, using a long-term loan that includes an adjustable rate opportunity can make for minimal contributions leading up to the change in office scenery and then a boosted payment figure after the new salary has begun to flow in. Simply put, the 40-year mortgage is a fantastic financial product for some buyers while others may only see a minimal benefit or even negative returns on the use of this type of financing.