Why 40 Year Mortgages Are Rotten Deals

40 year mortgages are designed to provide mortgage financing for individuals who do not have enough income to afford ordinary mortgage payments. By extended the repayment terms past the usual 30-year limit, the lenders can reduce the value of the monthly payments. But while the program was created under the best of intentions, it contains a number of flaws. Those flaws make it far less cost-effective on the long run than ordinary mortgages. In the worst-case scenario, they can become financial burdens. This is why home buyers are probably better off looking somewhere else.

Understanding Mortgage Loans

Most home buyers cannot afford to pay for a home out of their own pocket in one lump sum. This is why they usually take out a mortgage loan. It allows them to pay for the home now and gradually repay it over time. That time period usually lasts anywhere between 10-30 years. The payments are split into monthly installments. In addition to repaying the portion of the loan (the principle), the borrowers make interest payments. Interest payments are essentially fees lenders charge for managing the mortgage loans.

Understanding 40-Year Mortgages

The length of the repayment period is inversely proportional to the value of the principle. In other words, the longer the repayment period, the smaller the principle will be. In 40-year mortgages, the principle is much smaller than it would be for traditional mortgages of similar value. In theory, this allows borrowers to take out a mortgage that's worth more then what they can otherwise afford to repay. This is why government-sponsored enterprises such as Fannie Mae and Freddie Mac, as well as some private mortgage lenders, have touted 40-year mortgages a way to expand home ownership. Unlike some of the riskier mortgages that have become infamous in the wake of the collapse of the housing bubble, the principle will not change, which should make them more secure.

In reality, the situation is more complicated than that. For all their advantages, 40-year mortgages have significant disadvantages that can make them more of a financial burden than they initially appear to be.

Total Interest vs Total Principle

While longer repayment terms make the principle payments smaller, they also require borrowers to make more interest payments. In many cases, the total value of the extra interest payments will affectively cancel out whatever money the borrower saved with lower interest rates. In the worst-case scenario, they can wind up costing borrower more.  

The situation is further compounded if the 40-year mortgage has a variable interest rate. Unlike fixed interest rates, which remain the same for the duration of the repayment period, the variable interest rates will increase and decrease according to market conditions. Getting extra interest payments can be expensive enough--getting stuck with increasingly expensive interest rates over time can be outright financially draining.

Increased Risk of Default

While having longer terms allows the borrower to make smaller payments, it also increases risk. As the borrower repays the mortgage, he or she may run into circumstances that would cause his or her income to decrease. For example, a borrower may get laid off and have trouble finding another job. This has become a significant issue in the current economy. Revenues are down all across the board and companies are still reluctant to hire. And, when they do hire, they may offer a reduced salary, which will still affect the borrower's ability to repay the mortgage.

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