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Mortgage interest rates have experienced a steady climb in 2022, reaching their highest point since 2008 in September, according to Freddie Mac, with an average of 5.89% for 30-year fixed-rate loans.
Red-hot market conditions over the past couple of years have also seen an unprecedented spike in housing prices, which rose 40.2% between June 2020 and June 2022, according to the Federal Reserve Bank of St. Louis.
Some prospective homebuyers may wonder if a 40-year mortgage loan may be the solution to the rising cost of homeownership. While these loans do exist, they're not widely available and may not be anytime soon. Here's what you need to know.
Can You Get a 40-Year Mortgage?
It is possible to obtain a 40-year mortgage loan. However, these loans aren't considered qualified mortgages, which have a maximum term of 30 years. This means that the loan's originator can't sell it to mortgage investors, which is a common way for home lenders to increase their liquidity.
As a result, 40-year mortgages are typically only available from portfolio lenders, which are lenders that keep the loans they originate until they're paid off. This may include banks, credit unions, online lenders and private lenders. You can also work with a local mortgage broker who can help you find suitable lenders.
Because they're not widely available, they may not yet be a good option for the average homebuyer. Whether they become more popular, though, is a topic of debate among real estate experts.
In April 2022, the Federal Housing Administration introduced a 40-year mortgage modification option for borrowers with an FHA loan who are struggling to keep up with their payments due to COVID-19. Some conventional loans offer similar modifications for borrowers experiencing financial hardship.
Some experts say that making 40-year mortgage loans for new purchases more accessible could help solve the current housing affordability crisis. But others say that the drawbacks to borrowers may not be worth it in the long run.
How Does a 40-Year Mortgage Work?
On the surface, a 40-year mortgage may appear to be no different from a 15-year or 30-year mortgage other than the repayment term. In some cases, that may be true; you may be able to obtain a fixed 40-year loan or an adjustable-rate 40-year loan that functions like a traditional mortgage.
But as a non-qualified mortgage, 40-year loans may come with other features that could affect you differently:
- Interest-only payments: In some cases, a 40-year mortgage could start out as an interest-only loan for up to 10 years, after which your balance will be amortized over a 30-year period, as it would from the start with a 30-year home loan.
- Balloon payment: You may be able to take advantage of lower monthly payments for much of the repayment term, but you'll need to make a large lump-sum payment at the middle or end of the loan to satisfy the payment agreement.
- Higher closing costs: With a qualified mortgage, the federal government sets limits on how much lenders can charge with closing costs. That's not the case with non-qualified mortgages, which could mean a higher upfront expense.
- Negative amortization: With some non-qualified loans, the lender sets a minimum payment amount that may not even cover the interest that accrues each month. The result is that your balance will grow over time instead of shrinking, also known as negative amortization.
In all cases, you can generally expect a lower monthly payment because the payments are spread out over a longer period of time. But with a longer repayment term, you can also expect a higher interest rate.
Pros and Cons of 40-Year Mortgages
If you're considering a 40-year mortgage loan, there are some advantages, but in many cases, the disadvantages could outweigh them. Here's what to think about before you apply.
- Lower monthly payment: If you're worried about being able to afford monthly payments, this longer loan could provide some relief through lower monthly payments.
- More flexible loan structure: If you want some flexibility with your loan—maybe you like the idea of an interest-only period or low monthly payments with a balloon payment—you can get that with a non-qualified mortgage.
- Higher interest costs: While you won't be paying more on a monthly basis, you'll end up paying far more interest over 40 years than you would with a 30-year or 15-year loan. And remember, your closing costs could be more expensive, too.
- Slow equity building: Because you're paying less each month, it'll take longer to pay down the principal balance of the loan, which means it'll take longer for you to build equity in your home. This is especially true if you get a loan with an interest-only period.
- Higher interest rates: Non-qualified mortgages tend to be riskier than qualified mortgage loans. Between that and the longer repayment term, you can generally expect a higher interest rate with a 40-year loan.
- Difficult to find: Whether or not 40-year mortgage loans become more popular, they're currently not easy to find with major mortgage lenders, which means you have fewer options to shop around and compare offers.
Alternatives to a 40-Year Mortgage
If your primary goal is to cut your monthly mortgage payment, here are some potential options to consider:
- Pay mortgage points. Mortgage discount points allow you to essentially pre-pay interest as part of your closing costs in exchange for a lower interest rate. For a 0.25% reduction in your interest rate, you'll typically pay 1% of the loan amount. This may be worth it if you're planning on staying in the home for a long time.
- Make a larger down payment. The more money you put down, the less financing you'll need. As a result, you'll end up with a lower monthly payment. Plus, if you put down 20% or more on a conventional loan, you can avoid private mortgage insurance.
- Consider an adjustable-rate mortgage (ARM). ARM loans offer an initial period with a fixed interest rate, most commonly for five years, after which the loan switches to a variable interest rate. But that initial fixed rate is typically lower than the rate on a fixed-rate mortgage, and if interest rates go down before your initial fixed period ends, you can refinance to avoid a variable rate.
- Apply for a government-backed loan. Loans insured by the Federal Housing Administration, U.S. Department of Agriculture and U.S. Department of Veterans Affairs may offer lower interest rates, low or no down payment requirements and, in the case of VA loans, no mortgage insurance.
Whatever you do, take your time to research all of your options to determine the right path forward for you.
Prepare Your Credit Before Applying for a Mortgage Loan
Whether or not you're thinking about pursuing a 40-year mortgage, it's crucial that your credit profile is in tip-top shape before applying for a home loan. Check your credit report and credit score to determine where you stand and take steps to address potential issues that could affect your approval odds.
This may include paying down credit card debt, bringing past-due accounts up to date and more. Also, avoid applying for new credit in the six to 12 months leading up to your mortgage application because it could impact your credit score and your debt-to-income ratio.
As you prepare to apply for a mortgage loan, working to improve your credit can help you reduce your monthly housing costs and maximize your total savings.