The 40-Year Mortgage: A Good News, Bad News Loan

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Before looking at the bad news, let's look at the good. This type of mortgage can help people who just don't quite qualify for a 30-year loan to buy a home, explains Alfred King, Fannie Mae's director of public affairs. Fannie Mae doesn't make loans. It does, however, buy roughly one out of every four conventional mortgages issued in the U.S. today. As a result, lenders like to work closely with Fannie Mae to develop loans they can make and then sell to the agency. This gives the lender more money to use to make more loans, which they in turn sell to Fannie Mae, which then…you get the point.

"We have been working with credit unions on the 40-year mortgage for some time because we share similar goals: to help borrowers with affordability issues," King says. "So it fits with both of our missions, and it is particularly useful for underserved borrowers. It can also work for borrowers in high-cost areas because it lets them get into a home with a lower payment. Anyone who wants a lower payment would benefit." To find a lender offering 40-year loans in your area, call Fannie Mae's Consumer Resource Center at 1-800-7FANNIE (1-800-732-6643) for a list of participating credit unions.

When you apply for a mortgage—any mortgage--all of your finances are put under a microscope. The lender will examine your credit history and your day-to-day fiscal operations; focus on exactly how much comes in—and from where—and on how much goes out. Lenders want a complete list of your bills. Do you own a car? How many? Do you make car payments? How big is the payment--or payments? How much are your monthly utilities: gas, electricity, water, and so on? To whom do you owe money? What credit cards do you have? How big are those monthly payments?

Lenders use mathematical formulas to help them decide if you are financially trustworthy enough to make a particular mortgage payment. Unless your income and your expenditures are an exact match for the ones they like to see, you do not get the loan. Being $10 or $20 off could actually cost you your loan. This is where the 40-year mortgage comes in. Since the loan is being spread out over 40 years instead of 30, your monthly payment is lower—but only slightly lower. The fact that some people are turning to 40-year mortgages instead of standard 30-year loans shows that even a slightly lower monthly payment can spell the difference between getting a mortgage and having your loan application and chance for homeownership rejected.

King says that there is no extra set-up cost or additional loan origination fee for a 40-year mortgage, "but the interest rate is inherently a little higher than with a 30-year." After all, the longer a lender agrees to have money tied up, the greater the risk--interest rates could skyrocket; there are more opportunities for the borrower to forfeit the loan, and so on. That is why short-term loans almost always come with a lower interest rate than long-term loans. The 40-year loan usually costs 0.25 percent to 0.375 percent more than a 30-year loan.

Let's see what that translates into in terms of monthly payments and interest. A $100,000, 30-year mortgage at 6 percent would require a basic monthly payment of $599.55. This does not include taxes, insurance, or assessments. At the end of 30 years, the payments would total $215,838.53, of which $115,838.53 would be interest. Now let's look at $100,000 over 40 years, and let's say the interest rate is 6.25 percent. The basic monthly payment would now be $567.74. That's a monthly savings of $31.81 a month. That might not sound like a lot of money, but for many borrowers it's the difference between buying a home and continuing to rent.

But what is the long-term cost of that money? As we saw, the interest on the first loan would be $115,838.53 if the borrower kept it for the full 30 years. The interest on the 40-year loan would be $172,515. So that $31.81-a-month savings could end up costing $56,676.47 in additional interest payments over 40 years. While it is true that mortgage interest is tax deductible, most of us would still rather pay as little interest as possible.

While the extra interest definitely qualifies as bad news, it is not permanent. Odds are that anyone taking out a 40-year loan will convert it to a 30-year loan as soon as possible. Many lenders say that the average life of a loan today is less than seven years. At that point people either move or refinance. As we have seen, someone getting a 40-year mortgage is already close to qualifying for a 30-year loan. In this case, they were just $31.88 a month off. Being a homeowner gives them a bigger tax deduction, which translates into a bigger after-tax income that could be enough to push them into the 30-year loan range in a year or so—or maybe in even less than a year. But if rates go up, the homeowner can hang onto the mortgage until they go back down.

The important thing to remember is that a 40-year mortgage opens up the possibility of homeownership to even more people. Yes, the interest rate is higher, but as King points out: "It is not about the interest; it is about the home." The 40-year mortgage might not be the best deal around, but if it's the best deal you can get, then it is definitely good news. The 40-Year