The pros and cons of a 40-year mortgage

mortgage

The 40-year mortgage is popular with homebuyers, especially in the GTA where prices have risen sharply.

Let’s look at the pros and cons of extending a mortgage past the traditional 25-year limit.

Harriet and Henry are buying a home in the Greater Toronto Area. They both have RRSPs, from which they plan to borrow $40,000 for the down payment, and parents who can make up the difference.

The average home in the GTA sold for $380,000 last month. So, this couple puts down $76,000 (or 20 per cent) to avoid paying a costly mortgage insurance premium.

They shop around and get a five-year fixed mortgage term at 5.64 per cent with President’s Choice Financial.

Here are arguments in favour of a longer payback period:

You can qualify for a bigger house with a lower income: Mortgage lenders want to see a maximum of 32 per cent of gross income going for mortgage payments, property taxes and heating – and no more than 40 to 42 per cent of income going for total debts.

If Harriet and Henry have too low an income – or too much other debt – they won’t be approved for a mortgage without stretching out the repayment.

You don’t have to wait for your salary to go up: Waiting can be risky. You may cool your heels for five to 10 years before qualifying for the home you want.

By that time, you may find interest rates are higher than they are today. And you will be closer to retirement.

Let’s say Harriet and Henry are in their early thirties when buying their first house. They have at least 25 to 30 years left in the workforce.

But if they’re 40 or more before they can buy a home, they won’t likely pay off their mortgage before they retire.

You have more cash for living expenses: If your mortgage costs are punishingly high, you may have little left for other payments.

Harriet and Henry have a $304,000 mortgage. They pay $1,880.44 a month with a 25-year amortization.

But with a 40-year amortization, they pay $1,583.45 a month, cutting their monthly payments by $296.99 – or almost $3,600 a year.

They have more cash flow to pay for property taxes, utilities, repairs, insurance, transportation – and yes, maybe even a holiday or two.

Here are arguments against a longer payback period.

You pay more interest over the life of the loan: With a 25-year amortization, Harriet and Henry will pay $564,131.35 in total (assuming they renew every five years at the same interest rate).

They will pay a whopping $760,061.81 if they take 40 years to pay off the mortgage.

Let’s look at the cost of interest alone.

With a 25-year amortization, it’s $260,131.35. And with a 40-year amortization, it’s $456,061.81 – or half as much again as the initial loan.

You build equity more slowly and get back less of the money you paid in when you sell the house: Suppose Harriet and Henry go for a 40-year amortization.

A decade after buying a home, they still owe $276,589.17 on their $304,000 loan.

After 20 years, they still owe $228,783.96.

And after 25 years – when others have paid off their mortgages in full – they still owe $192,856.70.

So, how can you avoid this trap?

Increase your mortgage payments as much as you can.

Throw any other cash you have (such as income tax refunds) into the mortgage.

Your goal is to shorten the payback period and interest paid – and to fatten your own bottom line instead of the lender’s.

– by Ellen Roseman of the Toronto Star

Comment: Do you think the banks should offer 40-year mortgages, Milton?

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16 Comments

  1. JC says:

    I took a 40-year mortgage, immediately increased my payments and I am now on track to pay it off in 27 years. But should I ever need to reduce my payment back to the lower 40-year payment, I can without penalty. It’s a good strategy just in case something happens to your income.

    Reply
  2. Mike says:

    Have you looked at housing prices recently? To buy anywhere in the GTA, you would not only need a 40-year mortgage, but the rights to your first born, jobs 2-3 (not only dual-income families but sometimes triple or quadruple incomes) to find a 1,500 sq. ft. $500,000 bungalow south of Steeles. Oh don’t forget the privilege of paying the two (2) land transfer taxes by way of City of Toronto council, the vehicle registration tax because you live somewhere with an “M” postal code, and the outrageous taxes Miller implements because of the 905ers travelling into our city to work.

    Reply
  3. Dave says:

    The reality today is that house prices are far more expensive than they have ever been in terms of income levels. Thirty- or 40-year mortgages are the only way that many of us (newly graduated or people with young children) can afford to enter the housing market, especially if we want to live in Toronto versus the far-off-commuter-nightmare-suburbs. That’s a fact. While I agree that it may take longer for us to pay them off, at least we have a home that we can call our own. This is something I think most people want. It appears that those against 40-year mortgages loans have either bought their homes when prices were more reasonable or who have paid them off.

    Reply
  4. adam says:

    Borrowers have a responsibility to be informed of their financial options, and make appropriate decisions. This is just one more financial tool available to the public. If you are unrealistic about the mortgage you can afford, or how long it will take you to pay it back, then you deserve to get burned. Let the market dictate what types of mortgages are offered.

    Reply
  5. S. Upper says:

    Of course! Not all of us look at as a house strictly as an investment. We want to raise our families in a comfortable environment. Sure we could live in an apartment but we want a backyard for our child to play in. We want to be able to have family friends over to spend the night. The 40-year mortgage allows people like me to live in a nice house and still maintain a decent lifestyle. Mind you, we had to move to Scarborough to find value for our money but that’s beside the point.

    Reply
  6. Peter- Hamilton says:

    I have a 40-year mortgage. I even took 100 per cent financing. Shocking. But guess what? With accelerated payments, which are low and affordable, my 40-year mortgage is actually 31 years. The other thing, I didn’t buy in an overheated Toronto market because – guess what? – 450 grand for 700 square feet is ridiculous.

    Reply
  7. Bill says:

    I agree that lenders should be allowed to offer 40-year mortgages, but I feel that these mortgages should come with warnings and more education for the consumer. Ellen Roseman did the math in her column, but how many banks are pointing out these stats to their customers before they sign for a 40-year mortgage?

    Reply
  8. jeff says:

    The 40-year amortization allows buyers to get into the market earlier because the lower monthly payments qualify them for a larger mortgage. By taking a 40-year amortization you are not obligated to pay your mortgage off in 40 years. As the dollar value of your mortgage goes down due to inflation, and your income increases, you may increase your payment amount gradually over time, which will pay the mortgage off more quickly. Most mortgages also have the option of lump-sum payments, which can be exercised on any payment date and are applied directly to the principal balance owing.

    Reply
  9. WW says:

    When will people realize that these are products that are not in their best interest. Bite me once, shame on you. Bite me twice, shame on me. It is this “I want everything now” attitude that keeps many people from having “anything.”

    Reply
  10. Bill, Oakville says:

    While there are many dangers with a 40-year mortgage, with careful financial planning they can help you get more house sooner. What the article does not point out is that if you are confident that you will be increasing your annual income in the future, a 40-year mortgage could allow you to avoid having to “move-up” to a larger home as your income grows. This could potentially save you thousands of dollars in real estate fees, land transfer tax, etc. Lenders should definitely be allowed to offer these types of mortgages since they have a vested interest in ensuring people can afford such type of mortgages.

    Reply
  11. Deb says:

    As a homeowner, I can relate to the younger generation entering the world of homeownership. Who can afford a mortgage of $300,000 +? Housing costs have risen so much in the last 10 years I cannot fathom what the younger people are going to afford even in the coming years. But paying off a mortgage of this amount in, what, 25 years? Very hard to do, extending it would probably be the only solution. So yes a 40-year mortgage is reasonable.

    Reply
  12. J.W. says:

    No. A 40-year mortgage only encourages people to live in a cycle of debt. My father saw his parents lose their home in the depression. He was adamant that was not going to happen to him. He taught us “live frugally, pay off the mortgage as fast as you can, don’t ever let anyone put a debt against your home and once the mortgage is paid you can comfortably enjoy the fruits of your labour.” We have adhered to that philosophy and sleep peacefully at night knowing that as long as we pay our property taxes nobody can ever take our home away from us. Too many people want to have it all NOW, the big house, the flashy car(s), expensive holidays without ensuring that they have a secure roof over their heads first, swimming in a sea of debt. Not the way I want to live.

    Reply
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