Disadvantages of a 40 Year Mortgage

A 40-year mortgage promises mortgagees low mortgage payments over an extended amortization period. While it can work for a select few, longer mortgages have attendant risks and could end up costing mortgagees more. In assessing the worth of the 40-year mortgage, a mortgagee should critically examine how the demerits of it affect his specific circumstances.

♦ More interest repaid

One of the benefits of having a shorter amortization period is that it costs a lower nominal amount than a longer one. On a 40-year mortgage, mortgagees have an additional ten years to pay the loan – but this additional time comes at a significant cost. Exactly how much more it costs depends on the terms of the loan.

For instance, assume that there is a 30-year mortgage with an interest rate of 5%, and the principal is $300,000. The interest repaid is about $280,000 at the end of the period. With a 40-year mortgage on similar terms, the interest rate is likely to be marginally higher (5.25%). The interest repaid would then be $418,000. The additional ten-year period costs the mortgagee $138,000 extra.

♦ It takes a longer time to build equity

Home equity is the difference between the value of your house and the liability. As the mortgagee begins amortizing the mortgage, home equity increases because the value of the house might increase and the liability invariably decreases. With a 40-year mortgage, this happens as well. Unfortunately, because more interest must be repaid as part of the loan, and the lower monthly payments mean that it takes longer to build equity as well – compared to a shorter loan. Equity builds more slowly with a 40-year mortgage because it takes longer to pay off the loan.

♦ Higher interest rates

Since lenders want to be compensated for lending money for a longer period, the interest rate would not be the same as the interest rate for a typical 30-year mortgage. It is likely to be anywhere from 0.25% to 0.5% higher on average. Although the marginally higher rate yields a lower nominal monthly payment, it decreases the advantage of making a lower payment.

In addition to these points, a longer amortization period suggests that there is a theoretically greater chance of a default. Apart from that, the psychological and financial strain of long-term debt can affect mortgagees. Also, the lower repayment might seduce persons into buying a house that they cannot afford in the long run. The main question the mortgagee must answer is whether the marginally lower monthly repayment is worth the additional interest, impaired growth of home equity and the long-term burden of a mortgage loan.