Sooner or later, it had to happen: The 40-year mortgage has arrived.
A small but growing number of lenders are offering 40-year loans, in part because skyrocketing home prices have made it impossible for many borrowers to qualify for 30-year mortgages.
Stretching payments out over an extra 10 years lowers the loan's monthly carrying costs, which makes it easier for cash-strapped borrowers to qualify for the loan and lets well-heeled buyers get a bigger loan to buy a nicer house.
But while these longer-term loans may appeal to some borrowers, they're clearly not for everyone. The longer repayment schedule dramatically increases interest charges over the life of the loan, and equity buildup is much slower.
Some lending experts say those two drawbacks offset the benefits of a 40-year term's lower monthly payments.
"A 40-year term can lower your monthly payments a little bit, but you're giving up an awful lot for the privilege of making those smaller payments," says Dennis Casey of Home Federal Savings & Loan Assn., a San Diego-based lender that doesn't offer the stretched-out loans.
Lending giants Great Western Bank and the Home Savings of America unit of H.F. Ahmanson & Co. are among the institutions offering 40-year mortgages nationwide. A relatively small number of other lenders are offering them on a regional basis.
So far, all of the 40-year loans currently offered are adjustable-rate mortgages. Introductory rates stand at about 8 1/4%, roughly the same as rates on 30-year adjustables.
Initial principal and interest payments on a $100,000, 40-year ARM at 8 1/4% would total $714, or $37 less than the monthly payment on a 30-year, 8 1/4% loan for the same amount.
By comparison, monthly payments on a 30-year, fixed-rate mortgage at the going rate of 10 1/2% would be $915. That's $201 a month more than the payment on the 40-year ARM.
A 40-year loan's lower payments can make a big difference for many first-time buyers. The savings free up cash to meet other financial obligations, and also make it easier to qualify for the loan.
For example, cutting the monthly payment by just $37 reduces the amount of annual income needed to qualify for a loan by more than $1,200. In high-cost areas where larger loans are needed, the savings can have an even more dramatic impact.
Apparently, though, the 40-year loans aren't just appealing to struggling first-time buyers: They're also drawing interest from affluent people.
Beverly Hills-based Great Western started making the 40-year loans last December, after getting hundreds of appeals from realtors doing business in the Southland's high-cost coastal communities.
Although it's too early to tell whether the program is catching on with the public, says Great Western's Michael Cichon, "the realtors say there's good demand for it."
By choosing a 40-year loan instead of a 30-year term, home buyers can borrow more money because their monthly payments won't be as high.
But while the 40-year mortgage lowers monthly mortgage payments, it also raises the long-term cost of the loan dramatically.
Since the 40-year loans have adjustable rates, it's impossible to calculate exactly how much more in interest charges the extra 10 years will generate. Some lenders say finance charges over the life of a 40-year can be as much as 40% higher than interest charges on a 30-year loan, primarily because nearly all of the monthly payments in the first 15 or 20 years of a 40-year loan go toward principal, not interest.
As a result, a borrower who takes out a $100,000 loan could easily wind up paying an extra $80,000 to $100,000 in interest if the loan is paid off over 40 years instead of 30.
Of course, few borrowers actually keep their loans for the entire term; they usually sell their house and pay off the loan long before then. Borrowers who intend on staying in a house for a relatively short time--say, five or six years--will probably pay less than $2,000 in additional interest charges by choosing the 40-year plan over the 30-year term.
Paying an extra $2,000 or so in finance charges over five years isn't a problem for buyers in areas where home prices are rising fast, because their eventual resale profits will easily offset their extra financing costs.
But $2,000 can be important to buyers in markets where prices are advancing slowly, holding steady or dropping. Even if the value of the house goes up a few thousand dollars, the resale profit will have been eaten up by the extra interest costs. Add to that the cost of any sales commissions, and the home could wind up being a money-losing investment.
Casey at Home Federal admits that borrowers who can't quite qualify for the higher payments on a 30-year loan may be tempted to choose a 40-year mortgage. "If it's the only way you can get the money, then you might want to take it," Casey says.
"But the truth is, if your finances are so tight that you have to take 40 years to pay off your mortgage, you should probably start thinking about buying a less expensive house, or wait a little longer to save up more money for the down payment.
"You don't want things to be so tight that you can't afford to take your family to dinner every now and then," Casey adds.