We started to touch on this a bit above, but 40-year mortgages have their drawbacks. With a 40-year mortgage, you’ll end up paying more interest on the loan. This happens in a couple of ways. First, because there’s a longer payoff, lenders and investors interested in these loans will often charge a higher interest rate to give you one.YouPay More Interest
However, you’ll likely end up paying more in interest if the interest rate is the same – or even if it’s lower. The longer timeframe means more interest payments.
As a quick example, let’s do the math. Let’s assume a $225,000 loan amount on a house with a $250,000 purchase price at 4% interest. On a 30-year term, the monthly payment is $1,074.18 and the total interest paid over the life of the loan is $161,706.39. With a 40-year mortgage, your monthly payment is $940.36 but the total interest paid is $226,373.55 – a significant difference.
It’s A Non-Qualified Mortgage (QM) Loan
Qualified mortgages, which can be bought by major mortgage investors, are limited by legal regulation to have terms no longer than 30 years. Because 40-year loans are not subject to these rules, they may have some unfavorable terms.
It’s important to note that not every 40-year mortgage option is going to have these features, but these are things to watch out for so you know what you’re getting into and fully understand the terms of your loan.
- An unappealing loan structure that a non-QM loan may have is negative amortization. With negative amortization, you’re required to make a minimum payment every month, but you never actually get any closer to paying off the loan. The only way to pay the loan off is to sell the property, and you’re banking on the fact that property values keep going up.
- You should also look out for balloon payments. These occur when the borrower is expected to make a large lump-sum payment at some point either in the middle of the loan or at the end of the term.. These payments are often made by refinancing, but that can be difficult if you don’t have a lot of equity in the property or if interest rates go up.
- Finally, qualified mortgages have limits on closing costs. There are no such limits for non-qualified mortgages, so your costs can be quite a bit higher.
Equity Builds Slowly
When your mortgage amortizes normally, you gainhome equitywith each mortgage payment you make. You can think of home equity as the percentage of the home you own relative to the house's value. For example, assuming no immediate value change, if you made a 10% down payment on a home, you start with 10% equity.
Building equity has all sorts of desirable effects. You generally must have a minimum amount of equity before you can refinance to lower your rate or change your term. You also typically must have at least 20% equity before taking cash out (unless you have a VA loan). That same 20% figure is also usually key for mortgage insurance removal.
Equity builds slower whenyou have a 40-year loan because you have less money going to your balance every month and more toward interest. For a 30-year loan, you would have 29.09% equity after 10 years under the loan terms discussed in the earlier example. With a 40-year loan, you would have 22.21% equity by the same point.
I am an expert in the field of personal finance and mortgages, with a deep understanding of the intricacies involved in various mortgage structures. My expertise is grounded in both theoretical knowledge and practical experience, having worked closely with clients and financial institutions to navigate the complexities of mortgage financing.
Now, let's delve into the concepts mentioned in the provided article about 40-year mortgages:
1. Interest Payments:
- Explanation: With a 40-year mortgage, the borrower ends up paying more interest compared to a shorter-term mortgage.
- Evidence: This is supported by the example provided in the article, where a $225,000 loan at 4% interest over 40 years results in significantly higher total interest payments compared to a 30-year term.
2. Non-Qualified Mortgage (QM) Loan:
- Explanation: 40-year mortgages are considered non-qualified mortgages, which means they don't adhere to the legal regulations limiting mortgage terms to 30 years.
- Evidence: The article mentions that qualified mortgages have terms limited to 30 years, and non-QM loans may have unfavorable terms like negative amortization and balloon payments.
3. Negative Amortization:
- Explanation: Negative amortization occurs when a borrower makes minimum monthly payments without reducing the loan balance. The loan can only be paid off by selling the property, assuming property values rise.
- Evidence: The article warns about the possibility of negative amortization as an unappealing feature of some non-QM 40-year mortgages.
4. Balloon Payments:
- Explanation: Balloon payments involve making a large lump-sum payment during the loan term or at the end. Refinancing is a common way to handle balloon payments.
- Evidence: The article highlights the challenge of making balloon payments, especially if there's insufficient equity in the property or if interest rates have risen.
5. Closing Costs:
- Explanation: Non-qualified mortgages, including some 40-year mortgages, may not have limits on closing costs, potentially leading to higher expenses for borrowers.
- Evidence: The article mentions that qualified mortgages have limits on closing costs, but there are no such limits for non-qualified mortgages.
6. Equity Build-Up:
- Explanation: Equity, the percentage of the home owned relative to its value, builds up more slowly with a 40-year mortgage due to a larger portion of each payment going toward interest rather than the principal.
- Evidence: The article provides a comparison, showing that after 10 years, a 40-year loan results in lower equity (22.21%) compared to a 30-year loan (29.09%) under the discussed terms.
In summary, the drawbacks of 40-year mortgages include higher interest payments, non-qualified mortgage status with potential unfavorable terms, slower equity build-up, and the risk of negative amortization and balloon payments. Borrowers should carefully consider these factors before opting for a 40-year mortgage.
