The Lesser-Known 40-Year Mortgage: What You Should Know

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You’ve probably heard of 15-year mortgages.Thirty-year mortgages, too. But 40-year mortgages? They do exist — they’re not some sort of imaginary unicorn (there are even 10-year and 50-year mortgages, but we won’t discuss those loans here).

In the simplest terms possible, 40-year mortgages are home loans that can be taken out over a 40-year period, giving you more time to fulfill your loan obligations.

“This allows homebuyers to buy a home that perhaps they couldn’t afford with a traditional 30-year mortgage,” said Robert Johnson, professor of finance at Heider College of Business at Creighton University, and chairman and CEO for Economic Index Associates.

All aspects of a 40-year mortgage are the same as a 30-year mortgage, except that the principal and interest payments are spread over 40 years, reducing the size of your monthly payments and helping you manage your cash flow by lowering your main housing expense.

“It’s great for younger borrowers that are early in their career, because as they mature and earn more money, they can make larger payments on the mortgage to close it out early,” said Dennis Shirshikov, a financial analyst. “This is mainly because with lower payments, they are able to qualify for the mortgage based on their income and have some cash left over for all the other associated expenses.”

Before you take out a 40-year mortgage, you should examine the pros and the cons.

Advantages of a 40-year mortgage

  • You can borrow more money. Due to the longer amortization of the loan, you will have lower monthly payments, Shirshikov said. So you should potentially be able to afford to purchase a more expensive home than you would have been able to buy with a lesser-year mortgage. For example, if you were borrowing $300,000 with an interest rate of 7%, a 40-year mortgage would offer you a monthly payment of $1,864.29. With those same numbers in a 30-year financing, you’d be paying $1,995.91 monthly.
  • It’s an immediate solution to a cash-flow issue. If you have a shorter mortgage, such as a 15-year or a 30-year mortgage, you can refinance to a 40-year mortgage so that your monthly payments immediately go down, alleviating the fear of losing your home. But make sure it’s easy to switch back once you’re in a better position, financially.

Downsides of a 40-year mortgage

  • Interest is higher. The 40-year mortgage tends to have a higher interest cost overall, making it critical to repay the mortgage more quickly as your income increases and you are able to make larger payments. Typically, the interest rate is higher by at least 25 basis points than for a 30-year mortgage because the increased repayment time frame is associated with a greater overall risk profile for the lender, Shirshikov said.
  • Equity builds more slowly. Because you are paying off your mortgage over a longer period of time, you are also building the equity more slowly. Also, most of your payments are going toward the interest.
  • The housing market could change. In 40 years, your house could decrease in value, leaving you paying several times more than what the house is worth, Shirshikov said. According to a recent National Association of REALTORS (NAR) report, 12% of sellers wanted to move earlier than they did, but couldn’t because their home was worth less than their current mortgage balance. This is not a good situation, but it’s one that’s more likely to happen with a longer amortization period.
  • Early-repayment penalty. If you’re expecting your income to increase, and you plan on using the 40-year mortgage as a temporary solution for cash flow, you will need the option to pay early. “However, if your lender restricts or fines you for making early payments, this will likely erode the potential benefits of a 40-year term,” Shirshikov said.
  • It costs more in the long run. If you are late in your career and don’t expect a significant pay increase, or you are simply borrowing a 40-year mortgage for a home that you cannot afford, it’s important to recognize that fact and avoid the transaction, Shirshikov said. “In the long run, if your income is not increasing, or the house you are buying is too expensive, you will pay significantly more for the 40-year option over other options like a 30-year mortgage, or interest-only payments for the first few years, which many more lenders will offer,” he said. The interest-only option would allow you to pay only the interest on the loan for the first few years or make specific minimum payments that are lower than the interest. But if you opt for the 40-year loan, the financial difference could be significant, even on a relatively inexpensive home. For example, a 30-year mortgage with 4% interest on a home that costs $200,000 will leave you with monthly payments of $955 and $20,000 in equity over five years. After 30 years, you will have paid $143,739 in interest. With a 40-year mortgage at 4.25% interest, your monthly payments will be $867, but after five years, you’ll only have $10,000 in equity. After 40 years, you will have paid $216,275 in interest.

How to get a 40-year mortgage

These types of mortgages are less common than shorter-term loans, but are still obtainable — most likely from small banks (there are few, if any, large banks that offer 40-year mortgages due to the risks involved), credit unions or a bank with which you already have ties.
Credit requirements. As 40-year mortgages are typically uncommon and aren’t trusted by most banks, you should have a credit score of at least 600 to be considered, which is a bit lower than the average credit score. But the higher your credit score, the more likely you are to be accepted for this unusual loan.

Other requirements. Because a 40-year mortgage is considered to be a non-qualified mortgage under the Dodd-Frank Wall Street Reform and Consumer Protection Act, it isn’t eligible for insurance from the U.S. Veterans Administration (VA), the U.S. Department of Agriculture (USDA), Fannie Mae, Freddie Mac or the Federal Housing Administration (FHA). It also isn’t eligible for guarantee or for purchase from these government agencies. Translation: You will have to find a non-government lender, and many lenders don’t like the 40-year mortgage specifically because it isn’t deemed safe. Your points and fees on a qualified mortgage (QM) should be less than or equal to 3% of the loan, although for loans of less than $100,000, the lender may want a higher percentage. With a non-qualified (NQ) mortgage, you don’t have as many limitations and can receive a larger loan or 40-year financing.

How to apply. Choose what type of 40-year mortgage you want. They can be fixed or adjustable, but fixed is more common because of the potential range and fluctuation of interest rates over dozens of years. For example, the average interest rate in 2018 was 4.54%, which was higher than the 3.66% average in 2012 but significantly lower than the 16.04% rate in 1982.

Conclusion: The 40-year mortgage is a mixed bag. It allows homeowners to potentially purchase a more expensive home than they otherwise could not afford — but at the cost of higher interest rates, lower home equity over time and other issues discussed here. Before you seek one, make sure to ask your lender about prepayment penalties, as most people with 40-year mortgages will want to refinance or prepay (the average buyer owns their home for just nine years, according to the NAR) once they can afford to do so. When considering this type of loan, you really need to examine your financial future.

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