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Due to rising interest rates and higher home values, the monthly mortgage payment for a typical American home is 62% higher than it was a year ago. So it makes sense to look for ways to cut costs. But if you’re borrowing money to buy a house and think the answer to a cheaper mortgage is a longer-term loan, e.g. B. 40 years, think again.
The idea sounds simple enough — save on monthly payments and refinance to extend the life of the loan once interest rates drop to a point where it’s worth it. Also, a 30-year mortgage is a misnomer because nobody really holds the same home loan for three decades these days. So why not just go 40 years? There are many reasons not to play with the terms.
First, the monthly savings are unlikely to be enough. If you borrow $30,000 at a 5% interest rate for 30 years, fixed for the life of the loan, your monthly payment would be about $1,610, according to calculations by HSH.com, a consumer mortgage website . Is. Assuming the same interest rate on a 40-year mortgage (which is generous since interest on a 40-year mortgage is likely to be higher), the monthly payment would be about $1,447, a savings of $163.
Surely every little bit counts at a time when home affordability is at its lowest in decades, meaning it takes the average household income to qualify for a home-buying mortgage at an average price. However, this is not the case if you pay additional interest. In just five years, you would have been paying about $3,700 more in interest on a 40-year loan than on a 30-year loan, and about $11,000 more because your lower payment on a 40-year loan would have been borrowed. will be credited against the principal amount paid. And if you hold the loan for the full 40 years, you’ll pay $115,000 more in total interest than if you had opted for the 30-year loan.
And that’s why some lenders are happy to arrange a 40-year loan for you if you ask. They would prefer to capitalize on any other product that could seemingly make a home more affordable as it would help generate additional income. This is especially true now that mortgage activity has slowed this year.
It’s not like you can borrow much on a 40-year loan. According to the HSH calculator, assuming a $150,000 income and everything else, a long-term loan adds about $40,000 to the amount you can borrow.
Perhaps the biggest red flag with a 40-year mortgage is how slowly you build equity in your home, since more of your payment goes into interest than principal, compared to shorter-term loans. This could become an even bigger problem if house prices continue to fall or even if we enter a housing recession.
Remember that you typically need 20% equity in your home before you can refinance at a lower rate or adjust the term of your mortgage. Most people use far less than 20% and may not reach that threshold once they thought by 40 years old.
If you’re concerned that your monthly payment is too high, there are other ways to cut costs such as: B. awarding points to lower the rate, a larger down payment, or even variable rate mortgages. Ultimately, though, you should probably reconsider whether $200 a month is affecting or affecting your ability to buy a home.
Right now, 40-year mortgages are not backed by Fannie Mae or Freddie Mac. That means they don’t have the same consumer protection safeguards that come with compliant lending, such as capping exorbitant fees. Since you have to go to an online lender or a smaller bank or credit union, that rate may not be competitive either.
Earlier this year, the Federal Housing Administration, which supports loans for first-time buyers, said struggling homeowners can modify their existing 40-year home loans. (Fannie Mae and Freddie Mac also have an option to convert existing loans into a 40-year repayment schedule). Some saw this as a sign that the federal government might be able to pay off the loans as homeownership has become ineffective.
Extending the loan term to 40 years may be helpful for someone whose option is to lose their home, but given the mountains of interest and the slow pace of equity accumulation, I don’t see that new homeowners should have 40-year mortgage support constructive move for anyone other than banks.
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This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.
Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Before that, she ran tax reporting for Bloomberg News.
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