In order to understand the 40 year mortgage, we have to look at the history in which the concept came about.
The ìstandardî 30 year fixed rate mortgage was developed in the 1930s. In 1935, the average home cost $3450 and the average salary was $1600. That means, the average home cost just over two yearsí salary.
Fast forward to today. In 2005, the median home price in California was $524,000 while the average salary in that state was $43,000. As you can see, homes now cost ten times annual salary. This makes spreading the payments out over a 40 year mortgage quite attractive.
Another difference was that in the 1930s, people bought homes that they would live in until they died and then pass down to their children. Today, people live in a purchased home for just 8 to 10 years on average.
All of this makes the lower payment 40 year mortgage an attractive option for people whose home purchase is a temporary investment.
A 40 year mortgage may offer you a lower monthly payment. You may also be able to obtain a secure, fixed rate. But these mortgages typically have a balloon payment at the end of thirty years. AT that time, you have to refinance the loan or pay off the remaining balance.
A 40 year mortgage has lower payments than the 30 year fixed mortgage because it stretches out the amortization schedule over a longer period. The loan is actually only for 30 years, but is amortized over 40 years, thus the balloon payment.
An alternative to the 40 year mortgage is the interest only loan as it offers a similar low payment schedule. In some ways, the 40 year mortgage is more attractive though, because it allows you to build at least some equity in the home.
Both the 40 year loan and the interest only loan allow you to purchase a more expensive home than you can afford with the same amount of cash. A $200,000 home would be $100 per month cheaper with a 40 year mortgage than it would be with a 30 year fixed rate mortgage.
The people who will benefit most from 40 year mortgage plans are those who donít plan on moving from their home during the mortgage period. If you do move, you risk leaving the home during a downturn in the market which puts your entire investment at risk.
It made a lot more sense to take out 40 year loans when it looked like the housing market would continue to rise from year to year. In a depressed market, you need to be sure that you will be in the home for a long time before you take out a 40 year mortgage.
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