Is a 40-year mortgage worth considering?

Q: I grew up hearing about 30-year mortgages, but now I am seeing 40-year mortgages advertised more and more. Is that an option I should consider, or is 40 years just too long? For example, should someone sign up for a 40-year mortgage without being sure of staying in the house for 40 years?

A: Thirty-year mortgages may well have sounded radical when they were introduced, and with people these days living longer than ever, why not a 40-year loan? Well, while this type of product may have its uses, there are some important drawbacks.

Here are some things to keep in mind when considering a 40-year mortgage:

  1. Timing impacts risk, but it is not necessary to plan on staying 40 years. Your planned stay in the home does not have to match the length of the mortgage, just so long as there is not too great a mismatch. Because the initial payments on a 40-year mortgage are almost all interest and very little principal, these loans build equity very slowly. So, if you move after just a few years, there is a chance you will owe more on the house than you get for selling it.
  2. Look what the extra 10 years will do to how much interest you pay. Between the fact that longer loans generally mean higher rates and signing up for another 10 years worth of interest payments, a 40-year loan will cost you a lot more over the life of a loan. Before you commit, look at an amortization schedule to see how much more this option will cost you in the long run.
  3. Current mortgage rates do make longer mortgages more attractive. While keeping the above point in mind, at least current mortgage rates are low enough to take some the sting out of a longer repayment period.
  4. Leave time for retirement saving. The flip side of low mortgage rates is low interest earnings on savings accounts and other deposit vehicles. This makes it necessary to save more for retirement, and the longer you take to pay off your mortgage, the more those payments may crowd out retirement savings.
  5. Rent vs. own economics are a key factor. In some areas of the country, rents are extremely expensive, and while a 40-year mortgage may build equity slowly, renting does not build it at all. If this type of mortgage is truly cheaper than renting (when factoring in property taxes, insurance and other expenses associated with owning), it is worth considering.

This type of product may well be a necessary evil in parts of the country where housing is very expensive, but where possible, it would be better to settle for a cheaper housing choice (e.g., renting or a smaller home) than to sign up for something that builds equity so slowly.

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