Thursday, March 09, 2006

40 year loans

The Treasury Department's resumption of the 30-year bond sales and Fannie Mae's post-pilot program decision to purchase longer-term mortgages from private lenders is pushing the niche market 40-year mortgage into the mainstream.
That's good news for potential home buyers, especially those in high-cost housing markets like Northern California, who need the extra door-opening leverage of lower payments offered by a 40-year mortgage. Borrowers are demanding cash flow and lenders are accommodating in anyway they can.
That doesn't mean the longer term loans are for everyone. Even those who use them should be aware of their minuses as well as their pluses.
Previously Fannie Mae would not purchase loans with terms longer than 30-years, except from credit unions in the pilot program, leaving the loans on lenders books tying up the money for long periods. The loans big draw is the long term. A longer term means lower monthly payments. However, the devil is in the details.
To examine those details consider the March 3, 2006 Freddie Mac survey which said the average fixed interest rate was about 6.25 percent for conforming loans, loans no more than $417,000 for a single-family home.
Using self-help independent publisher's online calculator to calculate payments on a 30-year maximum conforming loan results in a $2,567 interest and principal payment. For a 40-year loan of the same amount, with the same interest rate, the monthly payments would be only $2,367. A $200 difference can be more than enough to qualify a borrower who couldn't afford to buy with a fixed-rated 30-year mortgage. But then there's that devil.
Those cheaper monthly payments are virtually erased, over the long haul, by the real cost of the loan. The 30-year loan would cost $507,315 in interest over the life of the loan. The 40-year loan would cost $719,393 over 40 years. Total payments for the 30-year mortgage would equal $924,315. For the 40-year mortgage, $1,136,393.
And the comparison isn't a real world comparison because the 40-year loan likely comes with an interest rate higher than the 30-year mortgage to offset the lender's longer term risk. Fannie Mae estimated lenders in the pilot program were charging from 0.25 to 0.375 percent more in interest for the 40-year loan, than for a 30-year loan.
Tack just 0.25 percent on the cost of a 40-year loan and at 6.5 percent the monthly payment jumps to $2,441, the total interest cost to $754,859 and total payments over the life of the loan to $1,171,859. In this example, the real monthly savings, when comparing a 40-year conforming loan level mortgage with a 30-year deal, is closer to $126.
Don't forget, if home equity is an issue, 40-year loans also build payment-related equity slower than 30-year fixed rate mortgages or even 30-year adjustable rate mortgages (ARMs).
Because many home owners historically don't stay put more than five to seven years or so (that could change as interest rates rise), if monthly savings is the leverage sought, an ARM could be a better deal for other reasons but considering ARMs' rate change risk, the 40-year loan can be an option for those who want to assure a monthly mortgage payment locked in at a lower level for a long time.
For the greater overall cost, the longer term gives the buyer more flexibility -- and perhaps more sleep at night -- in terms of when to decide if refinancing is a viable option. In the end, all loans can be a gamble. Risk varies from one to another. It's up to consumers to determine the level of risk they can accommodate.


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