A global pandemic followed up by a looming recession is the kind of once-in-a-lifetime double whammy that can really rock your financial confidence. Now, as interest rates spike, it raises the question: Could a 40-year mortgage option help solve housing affordability problems and remove some hurdles for first-time buyers?
Back in April, the Federal Housing Administration announced it was making a 40-year loan modification available to homeowners. The Fed’s hope is that by spreading payments out over 480 months instead of 360, existing borrowers have more sustainable monthly mortgage payments, which reduces the likelihood of foreclosures and short sales.
This spurred discussion around whether 40-year, fixed-rate mortgages should be a thing going forward — as it’s a loan product that’s not widely offered right now for those shopping for home loans. A side note here: There are some options for 40-year Interest Only (IO) loans, where the loan has a 10-year IO period and then converts to a 30-year fully amortizing fixed or Adjustable Rate Mortgage (ARM), which can also allow homeowners to save in their monthly payments, says Brian Rugg, chief credit officer at LoanDepot.
Currently, though, the good ol’ 30-year, fixed rate mortgage is the most popular loan product. There’s history behind this: The 30-year fixed mortgage has been the standard loan for years because it allows someone to buy a home at the age of 30 and have it paid off at 60, and then go into retirement with no mortgage payment, explains John Fricke, a loan officer with Canopy Mortgage.
The 40-year mortgage has never really taken off because of such a long payoff period, explains Bill Gassett, a Massachusetts Realtor at Maximum Real Estate Exposure, who has 35 years of experience. But it could make sense in today’s market — which is defined by parched inventory and increasing interest rates.
“By going to a 40-year mortgage, you can lower your monthly payments substantially,” he says. “When the market becomes more stable and interest rates start to slide back down again, a borrower could always refinance into a shorter term.”
So, what would be the pros (and the cons) of a 40-year mortgage?
The primary advantage of the 40-year mortgage is, of course, a lower monthly payment, Rugg says, which can help the large number of American homeowners who are behind on their mortgage payments. The number of homeowners who have fallen behind grew significantly during the pandemic, and with the nationwide foreclosure moratorium now expired, many are at risk of losing their homes, he explains.
“Another major consideration is that lower monthly payments provide greater purchasing power, allowing buyers to maximize their dollar to afford more house,” he says. “This could help first-time homebuyers break into today’s incredibly competitive, high-priced market.”
The downside, though, Rugg says, is that longer term loans often have higher interest rates, and when paired with the increased interest paid over the life of the loan it equates to a higher total cost. The longer amortization period of a 40-year mortgage also slows homeowners’ ability to build equity compared to more traditional loans.
The bottom line: Should 40-year mortgages become more common, they come with a unique set of pros and cons.