The Difference in Interest Between a 30-Year and a 40-Year Mortgage
A 30-year fixed rate mortgage is the most common home loan type used in the United States. In 2005, Fannie Mae started buying 40-year mortgages from lenders, allowing the longer term loans to become more widespread. The extra 10 years of term results in a lower monthly payment, but significantly higher total interest paid over the life of the loan.
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Rates and Payments
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Rate quotes for a 40-year mortgage are typically 1/4 to 1/2 percent higher than for a conventional 30-year loan. If the current rate on a 30-year mortgage is 5 percent, the monthly payment for a $250,000 loan would be $1,342 per month. With a 40-year mortgage at 5.25 percent, the monthly payment is $1,247. Selecting the longer term results in monthly payment savings of $95.
Total Interest Paid
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The big downside of a 40-year home loan is the extra 10 years of payments and total interest paid. In the example above, on the $250,000 loan at 5 percent, the total interest paid over a 30-year term would be $233,141. On the 40-year loan at 5.25 percent, a homeowner who completed paid off the loan would pay $348,639 in interest. The homeowner who selects the 40-year mortgage would pay almost 50 percent or $115,000 more in interest. Actual interest amounts will depend on the loan size and rates in effect at the time the loan is obtained.
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Shorter Term Results
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The home buyer who selects a 40 year mortgage may not be planning to pay the full term. The plan may be to go with the lowest payment and sell the home in 5 or 10 years. Over 5 years the payment savings adds up to $5,700 on the example mortgage and double that for 10 years. On the loan itself, the payment savings come from a slower principal pay down. After 5 years the homeowner with the 40-year mortgage has paid $4,200 more in interest and has a $10,000 higher loan balance.
Other Options
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The choice of a 40-year mortgage will result in a lower payment in exchange for higher interest payments and slower principal pay down through the life of the loan when compared to a 30-year fixed rate loan. A home buyer looking for a lower payment may be better served by a 5/1 or 7/1 hybrid loan with a 30-year term. These loans achieve lower mortgage payments through lower interest rates, at least for the first five or seven years.
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References
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