The advent of 40 year mortgages is likely to be criticised in retrospect as yet another bad decision by the mortgage industry, as they fly in the face of prudent borrowing. They enable borrowers to overextend themselves on the total borrowed in return for lower monthly payments, with the qualifying criteria lower than for shorter term loans. In return borrowers pay a higher interest rate, and unless they opt for refinancing at some point are likely to be saddled with mortgage debt into retirement.
Aspiring home owners are tempted by 40 year mortgages as they enable them to get a foot on the property ladder, purchasing homes which may otherwise be out of their price range. They are easier to obtain than shorter term mortgages, thus offering a way to home ownership which may otherwise be out of reach.
On the plus side 40 year mortgages can be a better investment than renting, particularly if the value of the property increases. However the property would need to dramatically rise in value to compensate for the interest payments exceeding the original loan amount. They can be a useful tool if the savings made are used to fund other long term investments, with refinancing planned for a later date.
The downside is that in return for lower monthly payments borrowers pay almost double the interest of a standard 25 year term loan, thus becoming an ideal vehicle for lenders who can cash in with the extra interest they receive.
It will take home owners much longer to acquire equity in their property, making them more at risk of negative equity as house prices fluctuate. Home owners who opt to refinance at some stage will find that their payments have gone towards interest instead of building up equity, thus reducing their options.
Whilst many homeowners have opted for refinancing in the past, the Federal Reserve now requires mortgage lenders to state that refinancing should no longer be considered as an easily available option. Those who choose long term mortgages may well find that their options become more limited when it comes to refinancing down the line, and they could well end up trapped by a mortgage which represents forty years of payments.
Forty years represents the term of most peoples working life, and the prospect of being tied to a loan for so long should raise alarm bells. A lot can change in the course of forty years, and there are more opportunities for something to go financially wrong, leading to foreclosure.
The idea of paying a mortgage during retirement is fiscally unsound. The small saving on monthly payments may appear to be a good move when the paperwork is signed, but over time the monthly saving will prove to be a long term reduction in future savings and investment opportunities.
At first sight 40 year mortgages may appear to offer a saving which makes home ownership a reality, but a mortgage should never be considered as a lifelong obligation. The true long term benefits are all on the side of the lender.