U.S. homeowners are increasingly prepared to consider a 40-year mortgage in order to reduce mortgage repayments and free-up funds for essential household bills. Does the higher borrowing cost make this a viable proposition for a homeowner or would a 15-year mortgage be a better option?
Advantages of the 40-Year Mortgage
- Lower monthly mortgage repayments. A $300,000 40-year mortgage at 5% would result in a mortgage repayment of $1456.95 per month. A 15-year mortgage at 5% would cost $2408.55 per month. This would reduce outgoings by $951.60.
- Avoid rental. Renting a house is dead money, but buying a house allows someone to potentially benefit from the development of home equity. It can prove to be a useful long term investment.
- Cash windfalls. Should a homeowner receive a windfall payment as a result of inheritance, a speculative win or a bonus it will be possible to clear some or all of the balance.
- Investment. A homeowner may believe that better returns can be achieved by investing the amount saved elsewhere.
Disadvantages of the 40-Year Mortgage
- Higher interest payments. Whilst mortgage repayments are reduced with a 40-year mortgage, cumulative interest payments rise dramatically. An additional 300 x $1,250 payments are made at a cost of $375,000.
- Negative equity. Home equity is built more steadily. This leaves a homeowner more vulnerable to negative equity in the event of a downturn in property prices.
- Scope for change. A 40-year mortgage is the maximum term of a loan. Should a homeowner experience financial difficulties, it is more difficult to free-up funds for other essential household bills. A 15-year mortgage provides greater scope.
- Outright ownership. It will be a long time before a homeowner has outright ownership. The longer the term of a loan, the more that can go wrong.
Robert Satnick, president of Prime Financial Services, said "What's nice about a 40-year loan - if it's not an interest-only loan - is that they are contributing something, even though it's a small amount, to pay down their principal."
Whilst the 40-year mortgage helps to reduce mortgage repayments and improves affordability, the increased borrowing cost may mean that it is not financially viable. High interest payments over the term of the loan mean that a homeowner should consider the 15-year mortgage as it builds home equity more quickly.
Sources
Geffner, Marcie. (June 18, 2009). "Is the 40-year mortgage a joke?" The Boston Globe.
Disclaimer: This article in no way attempts to give legal or tax advice. One should consult a licensed attorney, tax advisor, or other qualified professional.
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