40 Year Mortgages - Pros and Cons of a Really Long Loan
40 year mortgages are loans scheduled to be paid off over 40 years. They are popular with borrowers who want a low monthly payment. Of course, most people don’t keep a mortgage for 40 years, so 40 year mortgages are just used as a cash flow tool. Let’s get into detail about how 40 year mortgages work and whether or not they’re right for you.
Basics of 40 Year Mortgages
Most 40 year mortgages are fixed rate mortgages. They are built so that you pay off the loan over 40 years. This is relatively long, since most mortgages are 15 or 30 year mortgages. Even if you don’t actually keep a 40 year mortgage for 40 years, the loan is designed with a 40 year timeframe in mind.
Why Use 40 Year Mortgages?
Most people who choose a 40 year mortgage do so because they want a low monthly payment. If you use a 15 or 30 year mortgage, your monthly payment will be higher. By stretching out the loan, monthly payments decrease.
Problems with 40 Year Mortgages
While lower monthly payments may be attractive, there are always tradeoffs. Using a 40 year mortgage means you’ll pay more in interest and you’ll build equity more slowly. By using one of the calculators in the link above (or a generic loan amortization calculator) you’ll see how the total interest costs are higher.
It’s not just the longer time frame that increases interest costs. 40 year mortgages also come with higher interest rates. Expect to pay an extra .25% or more than you would on a 30 year mortgage.
If you’re looking at 40 year mortgages, you have to ask yourself: Am I buying more home than I can afford?
40 Year Mortgage Amortization
When we talk about mortgages, such as 30 year mortgages or 40 year mortgages, we’re talking about how long it will take to pay the loan off. With each monthly payment, you pay some interest and you repay part of the loan balance. With a 40 year mortgage, your final payment in year 40 will completely pay off the loan.
The process of paying down a loan is called 'amortization'.
When you change some part of a loan (the interest rate or length of time to repay it, for example), you change how quickly it will amortize. By lengthening the time frame, the loan amortizes more slowly.
Alternatives to 40 Year Mortgages
A 40 year mortgage might be perfect for you. If you do your homework and work closely with your lender, you may decide that it’s the best option. However, you should consider some alternatives and rule them out before moving forward.
Depending on your goals and your credit, interest only loans might accomplish something similar to a 40 year mortgage. You might have more luck finding an interest-only loan or a 40 year mortgage depending on the marketplace. See what the banks are offering before making a decision.
You should also consider borrowing less and using a shorter term loan. If you’re stretching to buy more than you should, it’s easier to get in trouble later.