40 Year Mortgage - A Guide To 40 Year Mortgages

40 year mortgage loans are not new and have been around for many years. But, up until the most real estate boom there had little use for an extended ten years of amortization that a 40 year loan offered. Real estate prices were relatively low, in comparison to average income. So, borrowers did not feel they needed to take on the added long term expense associated with 40 year mortgages. And, lenders did not feel they needed to offer a 40 year mortgage to increase the pool of eligible borrowers.

But, three things happened that forced the use of the 40 year mortgage back into the lime light. During the real estate boom between 2000 and 2004 real estate doubled in value. This pushed a good number of previously eligible borrowers out of the real estate market. The rampant availability of lendable funds between 2000 and 2006 far outpaced the pool of eligible borrowers. This means banks had to offer more creative financing options to increase the pool of borrowers available to use those funds and the 40 year mortgage was one of those instruments.

Last, as boom went to bust, and the mortgage industry melted down, combined with an economy in recession, more borrowers found themselves in the position of needing to refinance their mortgage loans. Since most of these borrowers had used the more exotic mortgage instruments and were border line bad credit borrowers there was no option but to do their mortgage refinance using a 40 year mortgage.

40 year mortgages at their earliest conception were basically the same as 30 year mortgages. Instead of being amortized over the standard 30 years, the 40 year loan was amortized over a 40 year period. The catch was that at the end of the standard 30 year period would be a balloon payment covering the balance of the last ten years of the mortgage.  The balloon payment at the end of the early 40 year mortgages did not make them very popular with borrowers.

The 40 year loan as we know it today, however, is structured exactly like a 30 year mortgage. The only differences between the two are the length of the term of the loan and the interest charged for the loan. It is what is considered a fully conforming loan. There are both 40 year fixed rate mortgages and 40 year adjustable rate mortgages.

40 year mortgages, as I mentioned earlier, are offered by banks, in general, to increase the pool of eligible borrowers. By offering a mortgage that extends the amortization period, the monthly payments are reduced. This reduction is not significant but many times it is enough to make a borrower that was previously ineligible, to buy a particular house, eligible.

Often a 40 year mortgage is offered as an alternate strategy to an interest only loan or an option loan.  This is because just like an interest only mortgage a 40 year loan enables decreased monthly payments. But unlike these other loan strategies t 40 year mortgages allow at least a little money to go towards the loan’s principle.

These types of longer term loans are often used by specific sets of borrowers.

• Borrowers that live in areas where real estate prices are exorbitantly high.

• Borrowers that qualify for a normal mortgage but do not have the full down payment.

• Borrowers wanting to move up to a more expensive house; but, just barely don’t qualify.

• Borrowers that are more concerned about current cash flow than how much they will pay for the mortgage over its term.

• Borrowers looking to refinance out of a mortgage, like an ARM, that they can no longer afford.

• Borrowers needing loan modifications in order to avoid foreclosure.

In the past there were very few lenders offering 40 year mortgages. These loans were considered nonconforming. Nonconforming, in short, means that a particular loan does not qualify under FHA rules. However, more and more lenders are beginning to offer these types of loans. This increased offering is driven by; demand for the loan, FHA rule changes, and Fannie Mae making the loan eligible for purchase.

As rules and laws are put in place to protect borrowers from the more exotic forms of mortgages it is likely that the 40 year mortgage will increase in popularity. This increase in popularity will be driven most likely as a response for a need for safer loan products.

Each lender has a specific set of criteria for loan eligibility. But, here are a few generalized criteria that a borrower has to adhere to in order to qualify.

1. Maximum debt to income value (DTI). Lenders want to be sure you can not only pay them back but cover all your other bills and living expenses. DTI is on average around 45% of your income.

2. Minimum credit score. Just like with any other loan you must have a qualifying credit score. Normally, your credit score must be at a minimum 620.

3. You must be an eligible borrower. Even if you have the right credit score and the right DTI you still may not qualify. A lot of times 40 year mortgages are used to target certain groups of borrowers like, first time home buyers, buying a house in a geographically targeted area, or possibly income limits.

4. Income limits. Lenders would rather have borrowers in more standard loans so they can retain the maximum value of the loan for when they sell it off. This is a way of forcing more qualifying buyers into a more standard mortgage, and therefore more valuable loan.

5. Maximum Assets. Some banks require maximum assets at around 20% of the value of the home. Again this is meant to push borrowers into more standard loans and therefore more valuable loans.

Not only does the borrower have to qualify but so does the property being mortgaged. Just like borrower qualifications, property qualifications vary from lender to lender. But, here are a few general ideas of what lenders look for in a property to qualify for a 40 year mortgage.

1. Maximum Loan To Value (LTV). This is a ratio between the mortgage loan and the actual value of the property. Some lenders allow higher than normal LTV with 40 year mortgages. Some allow LTV as high as 97%.

2. Some lenders may adhere strictly to Fannie Mae guidelines for 40 year mortgages. The lenders that do this are usually planning to immediately sell off the loan directly to Fannie Mae. That would be most lenders.

3. Almost all lenders are going to limit density of living space. Primarily, lenders do not want to inadvertently finance multi unit investment properties.

4. Lot sizes are often limited as well.

So, now that you know what a 40 year mortgage is, what is necessary to qualify, why would you want one. The number one most important reason to use a 40 year mortgage loan over any other standard mortgage is cash flow. You will not realize a huge decrease in mortgage payments. Depending on interest rates and other factors it could be up to a couple hundred dollars per month (You can use this loan calculator to see how a 40 year loan would affect you mortgage payments). Although, a few hundred dollars a month may not seem like a lot of money, but for some borrowers it makes a huge difference.

40 year mortgages are considered to be more flexible than other types of mortgages. There are a few reasons for this. First, having smaller monthly payments means that if you wanted to you could make extra payments directly to the loan’s principle if you wanted to. Now you can do this with a regular mortgage as well. But, you have less money to do it with at the end of each month. The terms that a borrower qualifies for a 40 year mortgage are generally more lenient than the standard 30 year fixed rate mortgage.

Although 40 year mortgages are more flexible and have a lot of great of advantages, they do have a ew drawbacks that you should be aware of. These loans generally have a slightly higher than normal interest rate; about .25% to .50%. The advantages gained by the extended amortization period is generally mitigated by the increased interest rate. That is why you will normally only realize a hundred or so dollar difference per month.

More important to some borrowers is how slowly you build equity in your property when you have a 40 year mortgage. You have to keep this in mind if you are buying a bigger house than you would have been able to afford using a different mortgage type.  So, if you are thinking that you can rely on built up equity in the later years, then you may want to rethink using this type of loan.

40 year mortgage loans should be used with caution. The extended amortization period will end up costing you more in the long run than the reduced monthly payments are worth. Although, in general they are easier to qualify for the do come with some heavy financial baggage that you should be fully aware of before making any commitments. If you are using this loan out of necessity or you are using it to correct an immediate cash flow problem then you need to make sure the return far outweigh the risks. Only you can tell if a 40 year mortgage is worth the risk or expense. If you are thinking about using the 40 year mortgage, then you should think of it as a tool. Does it fit what you need to do financially? You would not use needle nose pliers to work on big plumbing pipes. The same goes for a forty year mortgage. If it does not fit your financial needs then you should not use the 40 year mortgage.

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