MORTGAGE$: What about 40- and 50-year mortgages?

By William Kugel

I was surprised when I recently went on the internet and a pop-up advertisement offered me a 50-year fixed-rate mortgage loan. Frankly, even though I have worked in the real estate and finance industry for over thirty years, I have never seen this product before. With all the concerns raised over non-traditional mortgage programs in the past few years, I did not expect such a product to even be introduced in the wake of the many red flags that have been raised. In this article, I will review non-traditional mortgage cautions as well as possible benefits, make some broad comparisons between various products, and provide some insights into determining the appropriateness of their use. First, I made note that the 50-year products that I noticed were not from mainstream sources such as Freddie Mac or Fannie Mae. One program only fixed the interest rate for fifteen years. Therefore, a first note of caution is not to assume anything until you have reviewed a state or federal compliant loan disclosure. On the other hand, the 40-year fixed mortgage offered by Fannie Mae and Freddie Mac is a full-term fixed rate mortgage. Therefore, while I can say that the 40-year and 30-year conventional mortgages are close cousins, I do not think the same thing should be said of the 50-year mortgage. Over the past several decades, 40-year mortgages have come into vogue several different times, but never for any sustained period. The primary reasons for their appearance in the 1990s and their renewed usage now include the mortgage industrys efforts to expand their marketplace, the higher cost of housing in many areas, and upward movement in interest rates. A theme that has been prevalent throughout much of this decade is the mortgage lending industry's attempt to expand markets. One small part of this larger theme is the offering of loan products that stretch the borrower's ability to qualify. Forty-year mortgages do that. In areas where the cost of housing is high and/or is rising, this puts pressure on buyers in these regions to find ways to stretch their purchasing power. Forty-year mortgages are one of many ways of doing that.Yet another variation on the same theme is the two principal effects of rising interest rates. The higher the interest rates go, the harder it gets to qualify. A second effect of higher interest rates is that you now qualify for less of a home at the higher interest rates. Purchasing power has gone down. The mortgage lending industry has been coming up with a host of new products and loan options that help combat the effects at these higher rates. One way to stretch your ability to qualify, or increase your purchasing power, is accepting a 40-year amortization schedule on your new loan. I am often asked "Is this a good idea, or not?" As with many of the lending decisions that borrowers face today, it is not so much a matter of good or bad as it is more a matter of understanding the trade-offs involved. I will explore some of the pros and cons.According to Fannie Mae, "By increasing the standard loan term from 30 to 40 years, monthly payments are lower, thus making them more affordable, and increasing borrowers' purchasing power. The 40-year mortgage is ideal for borrowers who face affordability issues and think homeownership is beyond their reach. First-time home buyers or those living in high-cost areas seeking manageable monthly payments may find this amortization term attractive."For illustrative purposes, I computed the payments for a standard 30-year mortgage ($150,000 at 6.75 percent) and found the payment is $972.90. Fannie Mae indicated that the pricing for a 40-year mortgage might come at slightly higher rates. So then, I found that the payment for a 40-year mortgage (at 6.875 percent) is $918.56. The difference is a lower monthly payment of $54.34. On a 5 percent down transaction, this difference will increase an individual's purchasing power by approximately $10,000. One of the traditional arguments against 40-year (and now 50-year) loans has been that, over the full life of the loan, you will pay a great deal more in interest on a 40-year loan. One has 360 equal payments (30 years times 12 payments per year), and the other has 480 payments. Therefore, the total cost of the 40-year mortgage is $440,908.80 and the 30-year counterpart is $350,244.00. The difference ($90,664.80) is enough to scare anyone off the 40-year schedule (let alone a 50-year). Moreover, for decades the prevailing attitude regarding 40-year loans has been mostly negative. Some have even considered them imprudent. While the payments are lower, so little of each payment is going toward reducing the principal balance that it hinders building equity in your home. This and the higher interest costs are the principal disadvantages of 40-year and 50-year mortgages.One salient point that argues against this view is the fact that hardly anyone keeps a mortgage for 30, let alone 40, years. On average, lenders find that long-term mortgages are being retired somewhere between the fifth and seventh year. This is due to the mobility of our society, high divorce rates, rising and falling interest rate cycles, and other factors that stimulate refinancing, such as the desire for home improvements. In the example I used above, after six years, the actual difference in reduced equity buildup for that period is $6,170.49. I highly recommend this kind of number crunching and tailoring the evaluation to your specific circumstances. Once you have the numbers, you simply have to weigh the trade-offs that are applicable to your goals. Is qualifying an issue for you? Is more purchasing power needed? Do you have an overriding drive to keep your payments lower? Are you going to live there 30 years, or is five to seven years more likely? These are the kinds of questions that you need to ask yourself when considering your options. The size of your loan will affect the numbers. So, avoid generalizing and work from numbers that fit your specific situation.Fannie Mae also suggests that another application of the 40-year mortgage is for individuals who "have other financial obligations at higher interest rates that you would like to pay down, or you would like to optimize your investment strategy. A housing counselor or lender can help you evaluate if this mortgage is right for your specific circumstances." Seek out loan officers with experience and who contribute financial planning skills to your evaluation. Finally, keep in mind that 40-year mortgages are just one of many tools for stretching qualifying and purchasing power. The market place has exploded in the last decade with all kinds special mortgage programs. These products are designated for use by first-time buyers, moderate- to low-income situations, easy- or relaxed-qualifying, no income ratio tools, and low down payment scenarios. Another popular tool being offered is the 30-year Interest Only mortgages which will provide monthly options even lower than for 40-year mortgages. Take the time to survey the field and closely evaluate which of these approaches best meets all of your financial goals. As with any of these options, always make sure you can faithfully and fully discharge any encumbrance you undertake. The column MORTGAGE$ has been in continuous publication for 17 years. William Kugel is a senior loan officer with GMAC Mortgage Corp., and a Mount Washington Valley resident. You may contact him at 888-777-5099, write him c/o The Conway Daily Sun, visit the Web site www.gmacm.net/william_kugel or send email to william_kugel@gmacm.com.All Rights Reserved. Copyright 2007, W. H. Kugel