The 40-year mortgage may have a place in your finances, as long as you know both its good and bad sides.

Waiting 40 years for something important isn't necessarily a bad thing-look how well it turned out for Andy Stitzer in The 40-Year-Old Virgin. The 40-year mortgage loan theoretically puts off your debt-free existence for a full four decades, but the benefits might make it worth the wait.

Pay less to own more

During the last few years, lenders have begun rolling out 40-year mortgages as a way of easing the entry costs for homebuyers in high-priced real estate markets. Relative to the 30-year mortgage, its 40-year counterpart may offer lower payments on the same loan amount. Take, for example, a $260,000 loan with a rate of 6.5 percent; the payment on the 40-year loan would be about $120 less than the 30-year. This has obvious benefits for buyers, including the ability to stretch the home purchase budget.

There are a few variants of the 40-year mortgage, all of which have slightly different budget implications:

  • Fully-amortizing. A fully amortizing, fixed-rate, 40-year mortgage will be paid in full 40 years from the funding date, as long as the borrower makes all payments on time. The advantage of this structure is predictability; there's no change in interest rate or in the payment amount.
  • Balloon payment. Some lenders offer a 40-year amortization on a fixed-rate mortgage that matures in 30 years. This means that the borrower will have a balloon payment due 30 years after the loan funds. A borrower might like this structure if she expects to make extra principal payments throughout the loan's life, or if she intends to sell the home prior to the 30-year maturity.
  • Adjustable rate. An adjustable-rate, 40-year mortgage might have five years of fixed payments, followed by 35 years of rate adjustments. This structure is best suited for buyers who intend to sell the home or refinance during the fixed five-year period.

Downside of 40-year mortgage

Like anything else, the 40-year mortgage has its drawbacks. Homeowners will build equity very slowly, and the total interest costs during the life of the loan will be significantly higher. There's also the likelihood that the 40-year mortgage may have a higher interest rate than what's available on the 30-year loan. Since a higher rate puts upward pressure on the payment amount, borrowers are advised not to assume that all 40-year mortgages have lower payments. A better strategy is to obtain and compare quotes on 30-year and 40-year mortgages. That way, borrowers know they're getting the best deal available.

In situations where the borrower intends to refinance the loan or sell the home within a few years, these drawbacks may not be particularly significant. Most borrowers aren't likely to suffer through 40 years of waiting (a la Andy Stitzer) anyway; they'll use the lower payments to their advantage in the early years, and transition into more conventional financing later.

    Published on August 26, 2008