40 Year Mortgage

A 40-year mortgage seems seductively straightforward; increase the repayment period and reduce the monthly burden on the pocket. Indeed, the primary aim of the longer mortgage is to reduce the burden of monthly home loan payments. However, there are several attendant risks and demerits involved in increasing the amortization period of a mortgage. While it might be a good move for a select few to make, it is inherently high-risk. A 40-year old mortgage should only be accepted after careful consideration of its pros and cons, and the circumstances of the mortgagee.

== Merits of a 40-year mortgage ==

♦ Low monthly mortgage payment

The main thrust of the longer mortgage is the low monthly payment. Although there are other ways to get low monthly payments – such as the adjustable-rate mortgage (ARM), the 40-year mortgage is without the uncertainty of the ARM. Even if the 40-year mortgage has a marginally higher rate, the monthly payment would still be lower. For example, take a $100,000 mortgage with a 40-year interest rate of 6%. The monthly payment would be $550.21. If the amortization period is reduced to 30 years and the interest to 5.75%, the monthly repayment rate is still higher – $583.57.

♦ It facilitates a mortgage with a small down payment or no down payment

The benefit of the 40-year mortgage is that it precludes the need for a hefty down payment or allows smaller down payments. This is useful for those who have present liquidity issues that would be addressed in the future. Persons who are buying a home early in their career – when their income is low – can benefit from this. In addition, a 40-year mortgage better facilitates the purchase of homes in high-cost areas.

♦ It reduces the opportunity cost of taking a mortgage

Assume that a 40-year mortgage yields a meagre $95 lower monthly payment – compared to a 30-year mortgage. This might not seem like a lot, but if this $95 that is saved monthly is invested with an 8% return, it accumulates $307,000 at the end of forty years. The naysayers would immediately (and correctly) point out that the 40-year mortgage yields a much higher interest repayment.

According to the amortization schedule, the 40-year mortgage creates an additional $170,000 interest repayment. However, if the mortgagee were able to accumulate $307,000, it means that the mortgagee is still better off by $137,000. The present value of that $137,000 – assuming a high inflation rate of 4% – is $28,500, which is still a decent amount of cash. Therefore, the 40-year mortgage reduces the opportunity cost of taking a mortgage.

♦ Reduces the carrying cost of a rental property

The carrying cost of a property is the expense incurred by ownership. In accounting terms, a 40-year mortgage increases the overall liability, but decreases current expenses. So the current expense written off against a rental property would be lower relative to the income, ensuring a better profit (or at least a reduced loss). The owner of the mortgaged rental property can even have a buyer assume the mortgage later on, making it a clever strategy in that scenario.

♦ Tax deduction for high-interest earners
One of the weaker merits of the 40-year mortgage applies to high-income earners only. Mortgage interest payments qualify for tax deductions. Therefore, the higher interest repaid through a 40-year mortgage would reduce the chargeable income of high-income earners over a period.

== Problems with the 40-year mortgage ==

♦ Paying more interest

The short the amortization period is, the lower the interest repayment. Therefore, with a 40-year mortgage, the interest repayment is significant – given the additional 10 years. How much more? Well, that depends on the terms of the loan, but can be demonstrated by an example. A 30-year mortgage has an interest rate of 6% and the principal is $200,000. The interest repaid is about $231,600. However, take a 40-year mortgage on similar terms. The rate is likely to be a bit higher (6.25%); the interest repayment on that is higher as well – a whopping $345,000. That is an additional $113,400 over the ten extra years.

♦ Building equity more slowly

Equity is the difference between the value of your property and what you owe on it (Asset value – liability). Equity builds more slowly with a 40-year mortgage because it takes longer to pay off the loan. What exacerbates the issue is that you repay higher interest and have a smaller monthly payment towards the debt.

♦ Higher rates

According to bankrate.com, the 40-year mortgage interest rate might be 0.25% – 0.5% higher than a 30-year mortgage rate. Part of the reason for this is the added compensation lenders desire for committing their capital for a longer period. The marginally higher repayment rate on the 40-year mortgage helps to negate the lower monthly payments.

♦ Longer period of amortization

Staying for a longer period in debt increases the risk of default. Even if it does not, it is a psychological strain knowing that you still have your mortgage to pay off. If you take the 40-year mortgage when you are 25, you would spend the rest of your working life saddled with it.

Another demerit of the 40-year mortgage is that it might make mortgagees more inclined to buy “more house” than they could comfortably afford. In addition, the low monthly payment might not even be that much lower. For some persons, taking the 40-year mortgage might be a great deal or a solid stepping stone. However, that only occurs when their situation facilitates more pros than cons.