The Pros & Cons Of 40-Year Mortgages

Two traditional lenders in Massachusetts and three private ones may have a solution to putting people into homes: the 40-year mortgage.

The Federal Housing Authority does allow 40 years as a modification to existing mortgages if it will keep people in their homes during these COVID-19 inflicted times but, as of yet, 40-year mortgages aren’t purchased by the GSEs. The FHA sought comment on the possibility of making this modification permanent. Both the American Bankers Association, a trade association representing the country’s banks, and the MBA submitted comments to the FHA supporting the modification.

Interest-Only The First Decade

Needham Bank, headquartered in the Massachusetts town it’s named after, started offering a 40-year mortgage four years ago, while Metro Credit Union, headquartered in Chelsea, Mass., started offering this new loan three months ago. Needham’s is a 5/5 ARM, starting at 4.25%, while Metro’s is fixed at 4.5%. East Meadow, N.Y.-based Sprout Mortgage started offering a 40-year mortgage in July 2021.

“It’s a fixed rate for 40 years,” said Sam Bjelac, an executive vice president with private lender Sprout Mortgage. “There’s an interest-only feature for the first 120 months or 10 years and then the loan recasts into a 30-year fixed loan with principal and interest but the interest rate doesn’t change.”

While this type of mortgage is aimed at property investors, Bjelac says mortgage originators can offer it to homebuyers seeking a primary or secondary residence. Sprout Mortgage’s Chief Marketing Officer Bev Thorne said the interest rate on their 40-year mortgage is “hovering just above or just below 5% currently.” [As of June 10, 2022, the average 30-year mortgage rate was 5.23%]

As to where Sprout is seeing the most interest in these loans, Bjelac said, “It’s usually in the smiley face states. You go from California down through Arizona, into Texas, down through the Gulf Coast and into Florida. It’s more where you have investment properties.”

Atlanta-based Angel Oak Mortgage Solutions, another Non-QM player, offers a 40-year mortgage, says Steve Winokur, its chief marketing officer. It’s similar to the one offered by Sprout: The first 10 years it’s an interest-only loan followed by a more traditional 30-year fixed mortgage, which includes monthly principal and interest payments. Winokur says their 40-year mortgages are for people looking to buy and live in a home as well as property investors.

“The big difference for us is that people have to qualify on the 30-year portion of the mortgage,” said Winokur. “You can’t qualify on the interest only portion, when the payments are lower.”

Strong Numbers on Loans

Rockville, Maryland-based ACC Mortgage, another Non-QM entity, also offers a 40-year mortgage similar to the ones from Angel Oak and Sprout. It’s an interest-only payment for the first 10 years before converting to a 30-year fixed mortgage.

“It’s about 5% of our production,” said ACC Mortgage CEO Robert Senko, adding that his company has written about 20 of the 40-year mortgages at a volume of $35 million.

According to Mike Sinclair, Needham Bank’s executive vice president for residential and consumer lending, the bank, which writes loans mostly in the Bay State, currently has about 150 40-year mortgages worth about $120 million on its books. Because these loans aren’t purchased by the GSEs, Needham holds the loans.

Metro Credit Union CEO Robert Cashman says the credit union, with over 200,000 members, closed a few of these new loans; they only write mortgages in the Massachusetts.

“Being that we’re in Massachusetts and not in a rural part of the country, this has one of the highest housing costs in the country,” he said. “This type of mortgage addresses where our members are. Not everyone is going to make six figures and be able to afford a 30-year mortgage.”

Bjelac said that during 2021’s third quarter, 40-year mortgages “were 5% of our non-owner occupied loans. In this year’s first quarter, it was 25%.

“We’ve seen a big spike this quarter so far, and while we’re only about six weeks into it, it’s about 35% of our non-owner occupied loans. I attribute it to higher interest rates because professional investors are looking for lower cash flow payment options,” Bjelac added.

National Mortgage Professional Magazine talked with the experts about the pros and cons of this new loan.

The Pros:

With interest rates on the rise, a 30-year mortgage is more challenging for some, making the 40-year mortgage a viable option.

“It appeals to all kinds of people at all ends of the spectrum,” said Needham Bank’s Sinclair. “It appeals to a first-time home buyer, obviously, because they want to keep their payments down. It also appeals to a second-home buyer because they want to keep their payments down, and it also appeals to a step-up buyer who’s looking for a larger home because they want to keep the payments down.”

Metro Credit Union’s Cashman says there’s another group of people for whom a 40-year mortgage might work — retirees.

“When they retire, their incomes are cut,” Cashman said. “The mortgage payment they once made is more difficult and this (the 40-year mortgage) makes it easier for them to stay in their home.”

While she doesn’t write 40-year mortgages, Middletown, R.I.-based Embrace Home Loans Senior Loan Officer Dawn Ryan also thinks there are benefits to them.

“It could be the difference between qualifying and not qualifying for a mortgage,” she said. “It could also provide ease of mind in managing a monthly payment because it’s lower and, especially, with home prices not dipping, it could provide peace of mind.”

Said Angel Oak’s Winokur: “The 40-year mortgage is one of the ways to help out with affordability issues. We’ve been offering them for at least a couple of years now. People are looking at them more and asking a lot more questions about them than before.”

“It helps make the payments more manageable,” said ACC’s Senko, “The line I’ve always used is that you can’t pay less every month but you can pay more. If someone pays more, it will accelerate the equity position and principal reduction.”

Volatile times make the 40-year mortgage appealing.

“In the current environment, with housing stock lacking and causing the prices of homes to be exorbitant, the more difficult it is for the individual to come up with a down payment,” Cashman said. “We don’t control home prices; we don’t control the interest rate environment, which can make it difficult for someone to get into or stay in a home. The only thing we can do to combat this lack of affordability is time. That’s the reason for the 40-year mortgage.”

As an example, excluding taxes, the monthly payment on a $600,000, 40-year fixed mortgage with a 4.5% interest rate is $2,697.38. In comparison, the monthly payment on the 30-year fixed mortgage for the same amount, with a 5.25% interest rate, also before taxes, is $3,313.22: a difference of nearly $616.

“Anytime you can keep a borrower’s payment down, it definitely helps,” said Sinclair. “If they’re making a low-down payment, a first-time home buyer would also need mortgage insurance on the loan. A lot of times the difference between a 30-year and a 40-year mortgage can absorb the cost of the mortgage insurance for the borrower.”

The 40-year mortgage helps people and communities.

“The impetus for this is two things: we’re very focused on our community and affordable housing and helping people improve their financial well-being,” said Cashman. “Because prices are going up, the next generation is having trouble getting into their first home. This helps people get in place and stay in place.”

Ryan sees the benefits of the 40-year mortgage another way.

“Unlike our grandparents, mortgages are not one and done,” she said. “People do refinance, so the 40-year mortgage might be the way to get into the house.”

Mortgage originators need new loan offerings.

“With the increase in rates, even over the last six months, they (mortgage originators) are looking for more ways to originate loans,” said Bjelac. “If this had rolled out earlier, maybe a couple of years ago, it wouldn’t have been as popular. I think now that rates have risen, and their pipelines are smaller, they’re looking for more ways to qualify borrowers.”

When asked if she would like to offer 40-year mortgages to her clients, Embrace Home Loan’s Ryan replied, “If it helped the customer, certainly.”

Sprout Mortgage’s Thorne said 40-year mortgages offer “great flexibility for many (mortgage) originators, and, thereby, helps them as no other alternative does.”

More interest revenue

While 40-year mortgages take longer to pay back and, thus, require more interest payments compared to the traditional 30-year mortgage, there could be an upside because it means more revenue for the lender. Sprout Mortgage’s Thorne said, “It depends on the time and duration during which the mortgage is outstanding. It truly is a win-win for originators and lenders unless the loan is very short or very long.”

The Cons:

Paying more interest.

Both Ryan and Sinclair described the downside the same way.

“You’ll pay more in interest. But what if a customer makes one extra principal payment a year? They’ll reduce the loan by five-and-a-half years so that the 40-year mortgage isn’t really going to harm them that much more,” Ryan said.

Added Sinclair: “You’re not building up equity as fast as you would with a 30-year, 20-year or a 15-year mortgage. You’re basically working your monthly cash flow to get the lowest payment possible with a 40-year mortgage. So, if you don’t have the discipline to make extra principal payments, you’re not going to build up equity as fast.”

The length of time on the loan

While the length of the loan certainly means more interest payments, Sinclair and Cashman looked at this way:

“I don’t know that today’s borrowers, when they get a mortgage, ever think they’re going to see it through to pay off,” Sinclair said. “For the most part the average life of a loan is five years.”

Said Cashman: “People typically have a mortgage for seven to nine years. This is really a first-time buyer program, but we have borrowers who are all over the place, from those who are older to those who are five or six years out of college.”

The loans aren’t purchased by the GSEs

Freddie Mac spokesperson Angela Waugaman, in an email, wrote, “A 40-year mortgage isn’t a qualified mortgage (and) therefore the GSEs can’t purchase them. We will modify a loan for a distressed borrower to 40 years and did so during the pandemic if it meant the borrower could keep their home and still afford the lowered monthly mortgage.”

In her reply, she referenced the rules spelled out by the Consumer Financial Protection Bureau about what constitutes a qualified mortgage. They specifically prevent an “interest-only” period, when the interest is paid down without paying down the principal.

It’s the same with Fannie Mae. They retired the 40-year mortgage when they updated their Selling Guide in August 2013. Their cuide was updated to align with the Ability to Repay and Qualified Mortgage Rule. It requires a creditor to make a reasonable, good faith determination of a consumer’s ability to repay a residential mortgage loan according to its terms.

ACC’s Senko thinks it’s time for the GSEs to reconsider their position.

“Anything they can do to make housing more affordable would be helpful. But I’m a Non-QM guy. I don’t have any great insight into them but it makes sense. I wouldn’t be shocked if they did start (purchasing them).

The loans could require balloon payments

That’s the word in a blog piece from Detroit-based Rocket Mortgage, meaning the loans are written by private lenders, like Angel Oak Mortgage Solutions, Sprout Mortgage and ACC Mortgage and, as a result, aren’t regulated. In addition to paying more interest, the blog piece also warns readers that 40-year mortgages can sometimes require balloon payments.

Rocket spokesman John Perich wouldn’t comment further on the company’s position on 40-year mortgages, referring a reporter to the blog piece on the issue.