40-Year Mortgage: An Explanation And The Dangers Of The Loan

Homes are places to put down our roots, entertain and have sanctuary, but they can also be costly. One of the ways to make a house a little more affordable is lengthening the term, which is the central appeal of a 40-year mortgage. However, there are also some serious drawbacks.

Although Rocket Mortgage^® doesn’t offer them, we want to make sure you understand everything there is to know about a 40-year mortgage if you’re considering one so you can properly evaluate your options when applying for a mortgage. In this article, we’ll also run through some alternatives to a 40-year mortgage.

Yes, it’s possible to get a 40-year mortgage. Before we go any further, though, let’s make sure we touch on the basics.

What Is A 40-Year Mortgage?

A 40-year mortgage means that if you made all payments as scheduled without making extra or bigger payments toward the principal to pay it off sooner, it would take 40 years to pay off the home. More traditional mortgages come in shorter-term loans anywhere between 8 – 30 years.

How Does A 40-Year Home Loan Work?

These home loans can be fixed-rate mortgages, where your mortgage payment stays the same every month before accounting for property taxes and homeowners insurance. They may also be adjustable-rate mortgages (ARMs). These remain fixed at a lower rate than you can get on a typical fixed-rate mortgage at the beginning of the loan before adjusting up or down based on an index and margin after several years.

A 40-year mortgage may be refinanced. However, you’ll find that many sources of traditional mortgages don't offer 40-year loans.

These 40-year terms appeal to some because a longer time to pay off the loan means a small monthly payment. Depending on the mortgage lender, you may qualify for a lower down payment; if the payments are smaller, the loan could be considered less risky.

Because these mortgages aren’t backed by traditional parties, 40-year mortgages may only be available from portfolio lenders or those with access to nontraditional investors. Portfolio lending involves a lender holding on to the loan for 40 years until it’s paid off.

Not many do this anymore because it makes it difficult to fund very many mortgages. Most loans are immediately sold to one of the major investors. For this reason, you may have a hard time finding someone offering a 40-year mortgage. There are a few places to look, including:

• Mortgage brokers
• Online lenders
• Local banks
• Private lenders
• Credit unions

Let’s look at some of the big differences between a 30-year mortgage and a 40-year mortgage. Some of these are going to be obvious. Others, not so much.

• The term of a 40-year mortgage is 10 years longer. This falls under the “duh” category, but you’ll spend longer paying it off, so it’s worth reiterating.
• The payment on a 40-year mortgage should be cheaper. Because you have 10 years longer to pay it off, it would take a dramatically higher interest rate for the payment to be the same or higher than it would on a 30-year mortgage.
• You’ll pay more in interest. We’ll show our math in a minute, but a 40-year mortgage will cost you more over the life of the loan than a 30-year mortgage.
• These could come with higher interest rates and other fees. Because 40-year mortgages aren’t bought by major mortgage investors, they could charge extra fees and have other clauses that aren’t allowed by the major investors.

We started to touch on this a bit above, but 40-year mortgages have their drawbacks.

You Pay More In Interest

With a 40-year mortgage, you’ll end up paying more interest on the loan. This happens in a couple of ways.

First, because there’s a longer payoff, lenders and investors interested in these loans will often charge a higher interest rate to give you one.

However, you’ll likely end up paying more in interest even if the interest rate is the same or even lower. The reasoning for this has to do with the way loan amortization works. At the beginning of your loan, more of your payment goes toward interest than principal. Over time, this balance flips, but the longer your loan, the longer it takes for that to happen.

As a quick example, let’s do the math. Let’s assume a $225,000 loan amount on the house with a $250,000 purchase price at 4% interest. With a 40-year mortgage, your monthly payment is $940.36. The total interest paid is $226,373.55. On a 30-year term, the monthly payment is $1,074.18, but the total interest paid over the life of the loan is $161,706.39 – a significant difference.

It’s A Non-Qualified Mortgage (QM) Loan

Qualified mortgages, which can be bought by major mortgage investors, are limited by legal regulation to have terms no longer than 30 years. Because 40-year loans are not subject to these rules, that means they can have all sorts of not great provisions, but here are some to be aware of.

These 40-year loans might have an interest-only period at the beginning of the loan, during which you’re only required to pay interest. Although this can make your monthly payment even cheaper, it may also defeat the purpose of the 40-year loan and cause a payment shock if you have to pay the actual principal and interest payment for say the remaining 30 years.

The second negative loan structure you should be aware of is negative amortization. With negative amortization, you’re required to make a minimum payment every month, but the problem is you never actually get any closer to paying off the loan. The only way to pay the loan off is to sell the property, and you’re banking on the fact that property values keep going up.

Then there are balloon payments. These occur when a loan doesn’t or only partially amortizes over its term and at some point either in the middle of the loan or at the end of the term, the borrower is expected to make a large lump-sum payment. These payments are often made by refinancing, but that can be difficult if you don’t have a lot of equity in the property.

Finally, qualified mortgages have limits on closing costs. There are no such limits for non-qualified mortgages, so your costs can be quite a bit higher.

Equity Builds Slowly

As long as your mortgage amortizes normally, you gain home equity with each mortgage payment you make. You can think of home equity as the percentage of the home you own relative to the house's value. For example, assuming no immediate value change, if you made a 10% down payment on a home, you start with 10% equity.

Building equity has all sorts of desirable effects. You generally have to have a minimum amount of equity before you can refinance to lower your rate or change your term. You also typically have to have at least 20% equity before taking cash out (unless you have a VA loan). That same 20% figure is also usually key for mortgage insurance removal.

Equity builds slower when you have a 40-year loan because you have less money going to your balance every month and more toward interest because it’s a longer payoff. For a 30-year loan, after 10 years, you would have 29.09% equity under the loan terms discussed in the earlier example. With a 40-year loan, you would have just 22.21% equity by the same point.

Instead of choosing a 40-year mortgage that has flaws and may be hard to find anyway, it can be a great option to go with a 30-year mortgage. If you need a lower payment, the most practical thing to do might be just to set your sights on a slightly cheaper starter home and move up in a few years when you have more resources. This should be preferable to all the extra interest you pay on a 40-year mortgage. Other than a 30-year conventional mortgage, other options include:

• Federal Housing Administration (FHA) loan
• United States Department of Agriculture (USDA) loan
• VA loan
• Discount points

A 40-year mortgage may offer the benefit of a lower monthly payment because it’s a long-term loan; however, you’ll pay more in interest, and equity builds slower. This is harmful because equity gives you financing options. Also, because it’s a non-qualified mortgage, these come with higher costs and potential negative provisions to watch out for. Rocket Mortgage doesn’t offer 40-year mortgages.

We encourage you to familiarize yourself with the different types of mortgages that may be available to you. If you’re ready to get started, you can apply for a mortgage loan.