Published January 13, 2015
Sky-high prices are not preventing cash-strapped consumers from getting the house of their dreams now that lenders are letting them drag out the term of their mortgages to 40 years.
By moving from a fixed-rate 30-year to a 40-year loan, borrowers can stretch out loan payments and qualify for larger mortgages with lower payments.
While that seems to be good news for consumers, financial experts say the benefits are far outweighed by higher interest rates, 10 years of extra mortgage payments and a reduction in home equity.
"This (40-year) loan product screams of a budget-constrained consumer desperate to get into a home," said Gary Schatsky, a fee-only financial adviser/attorney. "This trend is disturbing to me, especially since it feeds into the growing obsession by consumers to get credit.
"They need to think through this mortgage's implications because in many cases, it will become their children's mortgage," said Schatsky, who is based in New York.
Incessant home price appreciation over the past few years has left some consumers with little choice but to seek riskier type loans, such as 40-year loans and interest-only loans.
The 40-year mortgage is more attractive than interest-only loans (search) because borrowers build equity in their homes, albeit at a sluggish pace, and they are not vulnerable to rising interest rates, said Celia Chen, director of housing economics at Economy.com, a consulting firm.
The 40-year fixed-rate mortgage was created in the late 1980s by several California savings and loan associations.
With house prices soaring, there has been an uptick in demand over the past year for the loans, according to several lenders.
Lenders' interest in offering 40-year loans may grow, since as of June, they can sell certain 40-year fixed-rate loans to Fannie Mae (search), the nation's largest mortgage finance company.
Thirty- and 15-year fixed-rate mortgages comprise about 70 percent of the market, with adjustable rate mortgages accounting for nearly all the rest, according to the Mortgage Bankers Association (search), an industry trade group. The MBA does not track 40-year loan applications.
Real estate brokers and lenders say consumers are being resourceful in taking out 40-year loans when double-digit home price appreciation has become the norm.
"Most borrowers do not plan to live in the house for 30 years, so a longer term is of no consequence," said Diane Saatchi, senior vice president with the The Corcoran Group, a major residential real estate firm.
"They figure to sell in about seven years; having 23 or 33 years left on the term is inconsequential," she said.
But 40-year loans have their critics, like Schatsky, who does not recommend them to to his clients unless they are severely cash-strapped or have a clear sense of future income streams.
Another research group, Bankrate.com, notes that interest rates on 40-year mortgages are generally 0.25 to 0.50 percentage point higher than on traditional fixed 30-year loans. That difference negates some of the benefits of the lower monthly payment.
Even with the same rate as on a 30-year loan, the 40-year loan's savings appear negligible.
For example, a $200,000 mortgage financed for 30 years at a fixed rate of 5.75 percent would carry a monthly payment of $1,167.15, Bankrate.com said.
By stretching the loan term an additional 10 years, borrowers, even at an identical interest rate, reduce their monthly payment by just over $100, to $1,065.78. However, the borrower also would have $16,389 less in equity at the end of the first decade of payments and would have paid an extra $4,200 in interest.
"This all stems from affordability and borrowers stretching themselves beyond their reach to get into a home they can't afford," said Economy.com's Chen. "What's next, a 50-year loan?"
Recent anecdotal evidence indicates that home price increases are beginning to decelerate, a sign the housing sector is starting to cool.
"When housing cools, so will these loans," said Schatsky. "If a consumer has to take out this loan to qualify for a home, their goal of homeownership needs to be seriously reevaluated."