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June 24 2006

40-Year Mortgages: An Alternative to Interest-only Loans?

Interest-only loans are quickly becoming a mainstream loan product. Borrowers who were initially turned-off by the perceived risk associated with an “interest-only” loan are now starting to see the benefits: Lower payments, less money tied up in equity, more flexibility, etc.

For the savvy borrower, an “interest-only” loan can be an important component to an overall financial plan -- allowing them to divert principal payments to other financial goals.

“Interest-only” is typically an option only available on adjustable rate mortgages (although some lenders are now offering this option on 30-Year Fixed Loans). Borrowers who plan on keeping the loan for a long period of time and are uncomfortable with a loan product that has an adjustable rate component, may be interested in the 40-Year Fixed Rate Mortgage.

(Note: Some lenders do offer a 40-Year term on their adjustable rate mortgages)

The more flexible underwriting guidelines of a 40-Year mortgage may also attract some borrowers who are interested but do not qualify for an interest-only loan.

A 40-Year Mortgage is exactly as it sounds – a mortgage that is re-paid over a 40-year term. Due to a longer repayment period, 10 years more than the standard 30-Year Mortgage, the monthly payments are lower.

Until recently, these loans were difficult to find. Fannie Mae has now announced they will begin purchasing these loans from lenders which should increase their availability.

Let’s look at the numbers:

For a $250,000 loan with a fixed interest rate of 5.75% and a term of 30 years, the monthly payments would be $1,458.93; but a borrower could save $83.40 a month by taking out a Fixed 40-year mortgage. Even at a higher interest rate of 6.00%, the monthly payments would be just $1,375.53.

The monthly savings comes with an increase in overall interest:

If a borrower were to keep the Fixed 40-Year Mortgage for the entire term and make the minimum monthly payments, they would pay approximately $135,000 more in interest.

40-Year Mortgages may be attractive to those borrowers uncomfortable with adjustable rate periods or who have difficulty qualifying under the stricter guidelines of an interest-only loan, however, it is important to understand the impact a 40-Year term will have on the overall cost of your loan.

As always, it’s best to consult with your trusted loan professional. They can help you understand your options and determine which loan product is best for you.

Apply for a loan now!

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