If you surveyed a handful of lenders, you’d likely find that the longest average term they allow is 30 years. Perhaps it’s because it’s the most common or because it’s the most risk they are willing to take. This doesn’t mean you can’t find mortgages that last 40 or 50 years, but they are much fewer and further between.
For comparison purposes, we’ll focus on the 40-year term, as it’s the longest a majority of lenders in the US will go today.
Why Would You Want a Longer Term?
40 or even 50 years seems like a really long time to have a mortgage. So why would anyone even consider it? Basically, it’s to increase affordability. If you want to buy a house outside of your budget on a 30-year loan, you may have a better chance with a 40 or 50-year loan. However, is it worth it?
The longer term means you pay on the loan for another 10 or 20 years. That might not sound horrible, but don’t forget about the interest. You’ll pay interest for another 120 – 240 payments on top of the standard 360 mortgage payments. That could mean thousands of dollars. This is something to consider.
The Benefits of a Longer Mortgage Term
Putting the larger amount of interest aside, let’s look at the benefits of taking a longer term.
- Helps you afford a home – If your debt ratios are just too high, meaning your income is too low, you may benefit from stretching the payments out, making them lower. This, in turn, helps lower your debt ratio.
- Help you stay out of debt – If you can take on a lower mortgage payment, you may have more disposable income to handle the cost of daily living. This could prevent you from racking up credit cards, which could work to your advantage in the future. It decreases the amount of interest you pay and helps you save money for emergencies, retirement, vacations, and more.
- Help you get a home right out of college – If your starting income isn’t nearly as high as your potential based on your degree, the longer mortgage term can help you afford a home now, while you wait for your income to increase. Down the road, you can have the goal to refinance your mortgage into a shorter term if it makes sense to do so.
The Disadvantages of a Longer Mortgage Term
As we already discussed above, a longer mortgage term costs you a lot more in the end. All things being equal (even though they probably wouldn’t), look at the difference between the 30 and 40-year term on a $200,000 loan:
- 30-year term – You’d pay $143,700 in interest
- 40-year term – You’d pay $201,200 in interest
That’s $57,000 more in interest. There are probably a lot of things you can do with that money, including saving for retirement!
It’s not just because you pay interest over a longer period, though. There are a few more reasons:
- You’ll pay higher interest rates – Lenders will likely give you a higher interest rate due to the risk that the longer term gives them. It’s not unusual to see an interest rate 0.5% to 1% higher as a result of the longer amortization period.
- You’ll have a mortgage into your golden years – If you are 25 years-old when you take out a 40-year mortgage, you won’t pay it off until you are 65-years old if you make the standard payment. That could take away from retirement savings and plans you have as you get older.
- You’ll have less home equity – The longer you stretch out a loan’s term, the less principal you pay with each payment. If you went to sell your home, you’d see a large portion of the funds from the sale go back to the bank to pay off your mortgage rather than being put in your pocket.
So what should you do? Generally, you should aim for the lowest term you can afford. Don’t worry if that means 40 years. While it’s not ideal, you know going into it what you have to do. Most mortgage programs allow prepayment. If you can make extra payments regularly, you’ll knock principal off the loan without much effort. Even an extra $100 a month can make a large difference.
Talk with several mortgage lenders to see what deals you can get. If a 30-year mortgage seems unaffordable at one lender, it doesn’t mean that’s the case for all lenders. Maybe you can find a lender with an interest rate low enough that you can afford the payment.
The key is to shop around and find the deal that is right for you. When you compare loans, make sure you compare apples-to-apples. In other words, don’t compare a 30-year term to a 40-year term. Once you see which loan is most affordable now and in the long run, you can make the decision that works best for you.