Apr 18, 2023
The hardest part of getting your family on the housing ladder is finding a foothold on the first rung. For many Americans, with today’s sky-high housing prices and soaring mortgage rates, it’s a feat that has become next to impossible.
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And others still may make their way onto the ladder but lose their foothold when they can’t keep up with their financial obligations.
However, a new policy change from the Federal Housing Administration (FHA) aims to give struggling Americans a better chance at holding onto their homes through challenging times. As of May 8, borrowers whose loans have been backed by the FHA will be able to modify their loan term to up to 40 years.
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Previously, loan modifications through the FHA were capped at 30 years. Melissa Cohn, regional vice president, William Raveis Mortgage, says this policy change is “a good sign of our federal agencies working to … keep people in their homes.”
And for homeowners struggling to make their payments, Cohn adds this could be the difference between keeping “people in their homes that may not have been able to stay there” otherwise.
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Many homeowners need mortgage relief
The FHA’s policy change couldn’t come at a better time — especially for many households still recovering from the financial hardship brought about by the COVID-19 pandemic.
During the pandemic, the FHA offered mortgage payment relief (forbearance) to borrowers in default or imminent default.
From the start of fiscal year 2021 through November 2022, more than one million borrowers — who were struggling financially due to COVID-19 — sought the FHA’s help to return to sustainable mortgage payments and avoid foreclosure.
Now, the FHA’s new 40-year loan modification policy would help struggling homeowners at risk of defaulting — or re-defaulting — as house prices and interest rates hover near record highs.
“A lower monthly payment is key to bringing the mortgage current, preventing imminent re-default, and ultimately retaining their home and continuing to build wealth through homeownership,” the the Department of Housing and Urban Development, the government arm that the FHA falls under, announced.
To be clear, the FHA isn’t offering 40-year mortgages as an option for new homebuyers or those looking to refinance their loan; it’s only an option for distressed homeowners at risk of foreclosure.
However, if the idea of a 40-year loan sounds attractive, there are options out there. From a lender’s perspective, it is considered a riskier loan so you’ll most likely have to turn to a non-qualified mortgage lender (non-QM lender). And that means your loan doesn’t conform to the set of rules established by the Consumer Financial Protection Bureau to protect borrowers from taking out loans they can’t afford.
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So before you make that step, it’s important to carefully consider the pros and cons of a four-decade loan term.
More: Could 50-year mortgages work in the U.S.?
40-year mortgage can get more Americans in homes
The 40-year mortgage is “a great tool” that can “help almost anyone” in the U.S. housing market, according to Cohn.
It’s particularly attractive to first-time home buyers and lower to middle income families who’ve been struggling to get on (and stay on) the housing ladder as mortgage rates and house prices near record highs.
“This type of loan can lower monthly payments, improving affordability and making it easier for some borrowers to qualify for a larger loan, as well as helping with cash flow and potentially freeing up funds for other expenses,” said Alex Shekhtman, CEO and founder at LBC Mortgage.
Based on the National Association of Realtors’ February’s median existing-home sales price of $363,000, here’s how that might look. With some help from a mortgage calculator, assuming you had a 20% down payment and an interest rate of 6.273%, along with the standard home insurance and tax rates, your monthly payment would be:
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- $2,208.47 on a 30-year fixed mortgage
- $2,069.51 on a 40-year fixed mortgage
That’s a difference of around $140 a month, which could go towards other vital expenses like food, childcare, health care, utilities and so on.
Some 40-year mortgages also offer unique features, like interest-only periods, that can lower your monthly payment for a set period of time — an attractive prospect for borrowers who need lower payments in the short-term but anticipate higher income in the future.
However, Shekhtman cautions that interest-only periods “can also result in negative amortization, where the loan balance increases rather than decreases over time.” So while the loan modification may help some homeowners out in the short run, the consequences may catch up to you later on.
It can also get expensive
While it might be the key to keeping many American households in their homes, there are risks with 40-year terms.
Even if your monthly payment drops with the new term, you’ll likely end up paying more interest over the life of your loan because there’s a longer payoff, which means you’re just spreading out your interest payments over a longer period of time.
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Back to the example of choosing between a 30-year and 40-year term for your $363,000 home: after 30 years, you’ll have paid $354,860.06 in interest. With a 40-year loan, that number climbs to a staggering $503,244.66. In this case, increasing your mortgage by 10 years would mean you pay $147,295 more in interest over the life of your loan — which equates to 40% of the original home price of $363,000.
And in reality, the difference in interest would probably be worse than this because 40-year mortgages typically carry higher rates.
With extended loan terms, It will also take you longer to build equity. Home equity is the difference between how much your home is worth and how much you owe on your mortgage. The more you pay off, the more cash you’ll come away with when you eventually sell.
And there’s also a chance that should home values fall, some of that equity you’ve slowly managed to build up will simply be wiped away.
So before you lock yourself into a mortgage for four decades, you’ll want to chat with a qualified financial adviser to make sure you’ve explored all your options and land on a loan that sets you up for ascending the housing ladder rather than threatening your financial footing forever.
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Bethan Moorcraft is a reporter for Moneywise with experience in news editing and business reporting across international markets.
