40 Year and 50 Year Mortgages - What Are The Risks?
You may have noticed recently that more and more lenders are advertising loans with terms of 40 or even 50 years. The reason for the longer term is simply to stretch out the payments, and thus lower your monthly payment. You will certainly be paying more in interest, but that really only applies if you plan on keeping your mortgage for a long time. The average borrower holds their mortgage for five to seven years. Most sub-prime borrowers re-finance their loan if even less time.
Sub-prime Market
Although 40 year terms are available to prime “A-paper” borrowers as conforming loans, the majority of 40 and 50-year mortgages are in the sub-prime market. While extending the term of your mortgage will lower your monthly payment, you will be paying much less of the principal down.
Let’s use the following examples:
Example 1
Assume you take out a $200,000 loan at a fixed rate of 7.5% for 30 years. Your total monthly payment would be $1,398.43. In the first month, $148.43 of that payment would go towards your principal and $1,250 would go towards interest. Your total interest paid over 30 years would be $303,434.45, with an average monthly interest payment of $842.87. It would take just over 21 years to reduce your principal to below $100,000.
Example 2
Next, we can look at a $200,000 loan at a fixed rate of 7.5% for 40 years. Your total monthly payment would be $1,316.14. In the first month, $66.14 of that payment would towards your principal and $1,250 would go towards interest. Your total interest paid over 40 years would be $431,747.90, with an average monthly interest payment of $899.47. It would take about 30 years to reduce your principal to under $100,000.
Example 3
Finally, we’ll take the same scenario, a $200,000 loan at a fixed rate of 7.5%, but with a 50 year term. Your total monthly payment would be $1,280.47. In the first month, only $30.47 of that payment would go towards paying down your principal and $1,250 would go towards interest. Your total interest over 50 years would be $568,280.32, with an average monthly interest payment of $947.13. It would take 40 years to pay down your $200,000 loan to below $100,000!
More Interest Paid
Obviously, it does not make much financial sense to keep these 40 and 50 year mortgages for their full term. The difference in total interest paid between a 30, 40 and 50-year term mortgages are astounding! These longer term mortgages are not designed to be held for their full term; rather, they are a way to save money on a monthly basis. They can be very useful however in the short term under certain conditions. If you’re purchasing a home in an area where property values are increasing rapidly, the increased appreciation of your home can make up for the fact that you are not paying down the principal as quickly.
Great “Starter” Loan to Minimize Payment
These longer term mortgages make sense if you are looking for a “starter” loan where you can minimize your monthly payments and build up a good credit history. Then, when you’ve got a higher credit score, you can qualify for the best fixed interest rates as a “prime” borrower.
