Even though mortgage rates dropped last week, many homeowners may still have a hard time making their monthly payments, particularly first-time homeowners. But a relatively rare mortgage product may make homes more affordable — the 40-year mortgage.
There are three reasons homeowners may want to consider a 40-year fixed rate mortgage: affordability, savings and security.
Fannie Mae has been working on a pilot program with 22 credit unions to test out these loans. Few banks offer this product right now, but a stamp of approval from Fannie Mae could increase the appeal.
Some credit unions working with Fannie Mae have seen great interest.
“It hasn't been limited to first-time home buyers who are looking to buy,” said Herb Behrens director of mortgage lending at Baxter Credit Union in Vernon Hills, Ill. “We've seen people looking at it from the refinance point of view trying to lower their monthly payment, as well as people who are on truly fixed income."
Affordable, but not cheap
Forty-year loans may be a little easier to qualify for than 30-year mortgages. Additionally, borrowers can often get bigger loans than with the 30-year fixed. Of course, few borrowers plan to stay in their home for 40 years, so the biggest draw is affordability, according to Leon Huntting, president of the California Association of Mortgage Brokers.
“People who are going to keep their mortgage only a few years but need that leverage to get in — the lower payment to get into housing — that's probably going to be best group for it,” he said.
On a $500,000 loan for a $650,000 home, you could save over $150 a month. If the interest rate is 5.75 percent on a 30-year fixed rate loan, the monthly payment would be about $2,900. Rates on 40-year loans are usually about a quarter-point higher than the 30-year. Since it's amortized over four decades instead of three, you pay only about $2,750 dollars a month. But your interest payments would be much greater and you're going to pay off less principal over the years.
There are cheaper ways to go.
With a five-year adjustable rate loan on the same mortgage, your monthly payment would be less than $2,700. Plus, you'd be able to pay about $5,000 more in principal over five years than with a 40-year loan.
“I am not sure if that 40-year will catch on because there are so many great options for people to keep a low monthly payment and pay it off faster,” said Bill Emerson, CEO of Quicken Loans. “Because the lower the interest rate, the faster they pay it off and they are able to take that additional amount of money and maybe invest it elsewhere.”
Still, a 40-year loan may be another option to consider as you weigh your need for cash flow, savings and building equity in your home.