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40 Or 50 Year Term Mortgages, Are They A Wise Choice?
Your parents probably purchased their home with a traditional 30-year fixed-rate mortgage and possibly lived there until retirement, right? The era of a homeowner sticking to their house payments for 30 years and paying the house off completely is all but a distant memory. Homeowners these days typically move or refinance every 3-7 years. Sometimes the reason is for cash out and sometimes it’s for a lower term on the mortgage. So taking a 40 or 50 year term isn't such a bad idea. It is one way to reduce your payments and still pay something towards principal.
30-Year Fixed-Rate Mortgage: The most common type of traditional mortgage, the 30-year fixed-rate loan, is most appealing to borrowers who want to stay in their homes for a longer period of time and who want more consistent principal payments during this period. Other benefits include avoiding rate adjustments and maximizing mortgage interest deductions for income tax purposes.
Example: A $300,000 loan with a 30-year fixed rate mortgage the 6.375% rate requires a monthly payment of $1,871.61.
40-Year Fixed-Rate Mortgage: With recent home values soaring, many lenders are seeking other options to offer prospective homebuyers as an alternative to the interest only loans that have become so popular over the last several years. Many lenders have already introduced the 40-year term loans, and Federal Housing Administration (FHA) (if passed in the FHA modernization bill) will also adopt the 40-year term loans as more of a mainstream option, along side 30-year fixed-rate and interest only loans.
The Positive: Stretching the traditional loan term amortization from 30 to 40 years can simply make the monthly payments lower; therefore making a home that might have been out of reach more affordable, increasing the borrowers' purchasing power, and making it easier to qualify for the loan. This loan provides a good option for first time homebuyers, or for those searching for a home in higher cost area's which would normally make a home purchase out of reach, this would allow for more manageable monthly payments and they may find this amortization term agreeable. The 40-year mortgage term is eligible on standard fixed-rate products as well as most standard adjustable rate loans.
The Negative: Before you run out to ask your bank or broker about the 40-year term, keep in mind that the interest rate is slightly higher; usually somewhere between 1/8 and 1/2 point higher. Remember also that for the money you save in the payment you will pay many times over in the form of interest over the additional ten year stretch. Generally speaking, this is only a good choice if you plan to refinance or move in 3-5 years.
With a longer amortization period, borrowers obtain lower mortgage payments.
Example: A $300,000 loan with a 40-year mortgage at 6.625% rate would require a monthly payment of $1,783.15 (assuming the rate is a quarter-point higher).
50-Year Fixed-Rate Mortgage: Like the 40-year fixed term, borrowers can extend purchasing power and/or enjoy an even lower monthly mortgage payment. With a 50-year loan you get the benefits of a payment similar to that on an interest only loan of the same principal amount, with the small exception that you will get to pay a little of the principle with every payment. These loans have drawn less interest from borrowers as most choose the interest only if it’s the lowest payment they are seeking.
Example: A $300,000 loan with a 50-year mortgage at 6.875% rate (having added another quarter-point of interest) would require a monthly payment of $1,776.42. [If only one-eighth of a point is added, making the rate 6.75%, the payment would be $1,747.88] Compare that to an interest-only loan for the same value at 6.875% rate and the monthly payment would be $1718.75.
Which one makes the most sense? When making such an important purchase decision, you should always try to go with the shortest mortgage term you can reasonably afford. The shorter mortgage terms typically have lower rates and the highest savings in interest. The recent negativity surrounding the adjustable rate mortgages combined with declining home values can make the longer terms loans a more viable option to avoid falling into such a situation. Additionally, in a high cost area there may be a well-founded need to seek out other affordable loan options. A prudent buyer will likely be precautious about purchasing more home than they can reasonably afford, while others may choose to stretch out the budget and mortgage term to obtain a more expensive home. These are personal choices that must be reviewed carefully as you are ultimately responsible for the payments.
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