In the early 2000s, it was pretty common to take out an interest-only mortgage, or a home loan with a very long term, such as 40 years (or even 50!).
Homeowners also had no qualms about negative amortization, with many willing to pick a pay option ARM and make the 1% minimum payment each month.
Regardless of exotic loan type, the motivation was the same – to keep the monthly housing payment as low as possible.
And it was all built on the same (flimsy) theory that home prices would appreciate endlessly, generating home equity in the process, even if the borrower was paying next to nothing each month.
We all know what happened once the bottom fell out – underwater mortgages, short sales, foreclosures, and countless closed banks and lenders.
You’ll Need to Get Your 40-Year Mortgage from a Non-QM Lender
The Qualified Mortgage was a direct response to the housing crisis that caused the Great Recession, and one of the many rules under QM states that loan terms cannot exceed 30 years.
The general rationale is that a mortgage with a term greater than 30 years results in excessive interest, an unnecessary burden to the homeowner.
Aside from taking a lifetime to pay off the mortgage, the amount of interest due is also much higher versus the traditional 30-year home loan.
Let’s look at an example to illustrate:
|Loan Type||40-Year Fixed||30-Year Fixed|
|Total Interest Paid||$216,275.20||$143,738.80|
As you can see, the borrower with the 480-month term mortgage would pay over $200,000 in interest on their $200,000 home loan.
Yes, you read that right. They’d pay more in interest than the original loan amount. This might be one reason the CFPB has a problem with loan terms over 30 years.
This is a result of the ultra-long amortization period, which stretches over 40 years, coupled with a slightly higher interest rate (it’s often an additional cost or rate increase for the 40-year option to boot).
The sad part is our hypothetical borrower only saves about $88 per month payment wise. Those paltry savings result in nearly $73,000 more in interest paid over the lengthier loan term.
Our poor borrower also builds equity at a snail’s pace, with the loan balance around $190,000 after five years and $176,000 after 10 years.
This can make it difficult to both refinance the mortgage, due to a high loan-to-value ratio (LTV), or even to sell the property if home prices are flat or move lower during that time.
It’s also pretty tough to buy a move-up property, as this borrower wouldn’t have much in the tank to plunk down for a down payment on the subsequent home purchase, assuming they were relying on existing home equity, which most do.
40-Year Mortgage Due in 30 Years
To make matters worse, many 40-year term mortgages were actually “40 due in 30 loans,” meaning they amortized over 40 years but were due in full in 30 years.
So this product is actually banned twice under the Qualified Mortgage rule, as it has a term greater than 30 years and a balloon payment.
The CFPB knows full well that these loan attributes can get homeowners into trouble, especially if the risks aren’t adequately explained.
It’s not to say they don’t have their place in the market, just more as a niche product than an everyday household mortgage for unassuming Americans.
Hopefully this illustrates why loans with terms longer than 30 years don’t fit the Qualified Mortgage definition.
If you want either a balloon mortgage or a 40-year mortgage, you’ll need to find a lender willing to underwrite loans outside the QM rule.
Or a business purpose loan such as a DSCR loan, where 40-year terms are common.
Fortunately, there are many non-QM lenders and the list is growing every day. Just approach with caution, as you should now know why they’re banned.
(flickr photo: Tom Page)