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The
Treasury Department's resumption of the 30-year bond
sales and Fannie Mae's post-pilot program decision
to purchase longer-term mortgages from private
lenders is pushing the niche market 40-year mortgage
into the mainstream. That's good news for potential
home buyers, especially those in high-cost housing
markets, who need the extra door-opening leverage of
lower payments offered by a 40-year mortgage. Mike
Donohoe, broker owner of Silver Creek Financial in
San Jose, CA says a year ago he had requests for
only one or two 40-year mortgages. Already this
year, the number has tripled to five or six
requests.
"It's across the board (in home prices).
Borrowers are demanding cash flow and lenders are
accommodating in anyway they can," said Donohoe,
also CEO of the Santa Clara County Association of
Realtors. That doesn't mean the longer term loans
are for everyone. Even those who use them should be
aware of their minuses as well as their pluses.
Robust demand met the Treasury's sale of 30-year
bonds in February the first sale of the bonds since
2001 and a new day for lenders who had relied upon
the government's shorter, less reliable 10-year note
for setting mortgage rates. The demand spurred the
Treasury to begin planning another 30-year bond sale
later this year and that will give lenders
longer-term guidance on setting rates for
longer-term 40-year loans and perhaps even 50-year
mortgages. The bond sale comes after Fannie Mae last
year strengthened the 40-year loan market by capping
a two year 40-year loan pilot program with credit
unions by announcing that it will buy the loans from
any qualifying lender. Previously Fannie Mae would
not purchase loans with terms longer than 30-years,
except from credit unions in the pilot program,
leaving the loans on lenders books tying up the
money for long periods. The loans big draw is the
long term. A longer term means lower monthly
payments. However, the devil is in the details. To
examine those details consider the May 3, 2006
Freddie Mac survey which said the average fixed
interest rate was about 6.25 percent for conforming
loans, loans no more than $417,000 for a
single-family home. Using self-help independent
publisher Nolo.com's online calculator to calculate
payments on a 30-year maximum conforming loan
results in a $2,567 interest and principal payment.
For a 40-year loan of the same amount, with the same
interest rate, the monthly payments would be only
$2,367. A $200 difference can be more than enough to
qualify a borrower who couldn't afford to buy with a
fixed-rated 30-year mortgage.
"In the higher end, more than ever before, a
lot of people are asking about them. With homes at
$750,000 and above that's the only way out there to
get into one," said Mark Hicks, real estate and
mortgage broker/owner of Seabrooke Financial Group
in San Jose. But then there's that devil. Those
cheaper monthly payments are virtually erased, over
the long haul, by the real cost of the loan. The
30-year loan would cost $507,315 in interest over
the life of the loan. The 40-year loan would cost
$719,393 over 40 years. Total payments for the
30-year mortgage would equal $924,315. For the
40-year mortgage, $1,136,393. And the comparison
isn't a real world comparison because the 40-year
loan likely comes with an interest rate higher than
the 30-year mortgage to offset the lender's longer
term risk. Fannie Mae estimated lenders in the pilot
program were charging from 0.25 to 0.375 percent
more in interest for the 40-year loan, than for a
30-year loan. Tack just 0.25 percent on the cost of
a 40-year loan and at 6.5 percent the monthly
payment jumps to $2,441, the total interest cost to
$754,859 and total payments over the life of the
loan to $1,171,859. In this example, the real
monthly savings, when comparing a 40-year conforming
loan level mortgage with a 30-year deal, is closer
to $126. Don't forget, if home equity is an issue,
40-year loans also build payment-related equity
slower than 30-year fixed rate mortgages or even
30-year adjustable rate mortgages (ARMs). "In
areas where values are rising by 15 to 20 percent in
a year, they don't care about the principal as much.
After a few years, they are refinancing
anyway," said Hicks who works in Silicon Valley
where in January, the median home price was nearly
14 percent higher than a year ago. Because many home
owners historically don't stay put more than five to
seven years or so (that could change as interest
rates rise), if monthly savings is the leverage
sought, an ARM could be a better deal for other
reasons. Consider the current Freddie Mac 5.9
percent average rate on a five-year hybrid (5/1)
ARM, which remains fixed for the first five years
and then adjusts once or twice each year for the
next 25 years. Put a 10 percent interest rate cap on
a 5/1 loan, beginning with the current average rate,
adjusting each year after the initial five year term
and the payment for those first five years would be
$2,473 a month, nearly equal the 40-year loan with a
fixed rate. Over the life of the loan the full cost
would be $1,193,836 for the 5/1 loan. Other ARMs,
including 3/1s or 1/1s, could push the monthly cost
even lower. "But with the ARMs you still have
that fully indexed rate (cap) that scares people
off," said Hicks.
After the initial term expires on a hybrid ARM,
you'll have to determine if you can afford the new
monthly payment based on the adjusted rate. At that
time, refinancing may be necessary to keep payments
low, provided interest rates have not moved too
high. Considering ARMs' rate change risk, the
40-year loan can be an option for those who want to
assure a monthly mortgage payment locked in at a
lower level for a long time. For the greater overall
cost, the longer term gives the buyer more
flexibility -- and perhaps more sleep at night -- in
terms of when to decide if refinancing is a viable
option. In the end, all loans can be a gamble. Risk
varies from one to another. It's up to consumers to
determine the level of risk they can accommodate.
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