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Long an oddity in the lending industry, the 40-year mortgage finally has joined the mainstream of home loans. Fannie Mae, which buys roughly one out of every four conventional U.S. mortgages, started buying the longer-term loan on June 1, putting it on an equal footing with the more-familiar 30- and 15-year fixed-rate, interest-only, and adjustable-rate mortgages (ARMs).
For lenders, Fannie Mae's move means they likely will offer more 40-year loans because lenders no longer need to keep and service the loans themselves, wait for the loans to be paid off, collect monthly payments, handle property taxes, and so on. They will be able to sell the 40-year loans, using cash from the secondary market to create other loans.
But what about consumers? How will they be affected? Sandy Cutts, a Fannie Mae spokesperson in Washington, D.C., explains that a 40-year mortgage is just like a 30-year mortgage—only 10 years longer. Cutts adds that Fannie Mae is willing to buy both conventional loans and ARMs that can be paid off over 40 years. We’ll look at the mechanics and costs of both types of 40-year mortgages a little later.
So who would use a 40-year mortgage? “There are two types of people who use 40-year loans,” she explains. “They are for those who are experiencing financial problems because they live in financially challenged markets where affordability is an issue, and for those people - often first-time buyers - who are concerned about making their payments manageable. It has its pros and cons. Its greatest advantage, the longer amortization period, is also its greatest disadvantage.” She adds, however, that since homebuyers typically move or refinance their loans every five to seven years, the long-term costs are not really an issue for most people. The issue is the size of the monthly payment and how much house that payment can buy.
The key point is that the monthly payment is lower a 40-year loan. “It (40-year loan) is not for everyone,” Cutts points out, “but that lower payment means there is more money available every month that can be used to pay other bills. It can often make the difference between owning and not owning a home.”
Before comparing 30- and 40-year mortgage costs, consider that 40-year mortgages are slightly more expensive rate-wise simply because the lender is risking money for an extra 10 years. “The interest rate on a 40-year mortgage, on average, is 0.25 percent to 0.375 percent higher than on a 30-year,” she adds. This applies to both the conventional and ARM loans. And while ARMs with a 40-year duration are still rare, the fact that Fannie Mae is now buying them guarantees you will be seeing more of them. So a 3-year ARM spread over 30 years with a starting interest rate of 4.5 percent probably would translate into 4.75 percent for a 3-year ARM over 40 years.
But let’s focus on the conventional mortgages, the most common 40-year loans. A 30-year, $150,000 conventional loan at 5.5 percent would require a basic monthly payment of $851.68. That would be interest and principal, and would not include taxes, insurance or any assessments or fees. As we have seen, to get that same loan spread over 40 years you would pay a bit more. If you could get it for 5.75 percent, your basic monthly payment would be $799.33 a month, for a monthly savings of $52.35, which works out to $628.20 a year. On a $250,000 loan the basic monthly payment for a 30-year loan at 5.5 percent would be $1,419.47. A 40-year mortgage at 5.75 percent would require a payment of $1,332.22. The difference here is $87.25 a month or $1,047 a year.
While many of the people who use 40-year loans are doing so because money is tight, a lot of people will use them because homes are so expensive. So let’s look at a loan for $359,650—the most you can borrow before getting into the jumbo loan category (which Fannie Mae won’t buy) and the different requirements, conditions and interest rates that kick in at that threshold.
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