Cash is always king. But if that's not an option, is a 40-year mortgage a good way for homebuyers to jump over the affordability hurdle?
First, cash: Buyers who can pay the full boat without financing have a leg up because there are no lender rules or appraisals to worry about, and therefore, little chance the deal will fall through.
Lately, in an effort to beat out the competition for the few houses that come to market, more buyers are going the cash route. According to Redfin, in October of 2022, 31.9% of all house purchases were made with cash -- the highest percentage in nearly a decade.
While it's admirable that they have enough money -- whether from savings, investments or inheritance -- to do this, do buyers really want to tie that much to a single asset? Especially one that might not always rise in value over time?
Sure, the stock market hasn't performed that well lately, mostly because the Federal Reserve Board has driven up interest rates to control inflation. And yes, earnings on savings accounts and CDs aren't what they used to be.
But eventually, inflation will be tamed, and the stock market should take off again (though savings accounts at banks may never pay as much as they once did). It's important to have some cash set aside in case of an emergency -- some financial experts suggest six months' worth of your total expenses.
It's a conundrum, all right. But there is a way for buyers to pay cash and then finance their purchases later. The little-known technique is a "delayed financing exception," offered through Fannie Mae, a government-sponsored enterprise (GSE) that buys loans from the Main Street lenders you and I deal with.
For the exception to work, your cash deal must adhere to Fannie Mae's rules. For starters, the sale has to be an arm's length transaction, meaning that the buyer and seller are acting independently and have no prior relationship. Then, you have to meet all of the GSE's borrower eligibility requirements, including a good credit score, a manageable debt-to-income ratio and an acceptable appraisal.
After that, you must act fairly quickly: You only have six months from the day you closed on the property to close on the financing.
The loan amount cannot exceed what you paid for the house, as documented by the settlement statement, plus closing costs, prepaid fees and points on the loan. And there can be no existing liens. If there are, they must be paid off either before closing or with funds from the new mortgage.
Finally, expect to pay an interest rate commensurate with what other borrowers are paying for cash-out refinancings.
Now, about 40-year mortgages: There has long been talk about 40-year loans as a way to make house payments more affordable. The Federal Housing Administration is now allowing struggling borrowers to extend their payments out four decades, leaving would-be buyers wondering when such loans will become available to the masses.
Spoiler alert: They already are, but they are not plentiful. "A 40-year is a pretty rare offering at the moment," Keith Gumbinger of HSH.com, a mortgage information website, told me. The reason: a "super-small audience and likely zero secondary market" where lenders can offload their products to investors.
Gumbinger pointed to a few mortgage companies and credit unions that write some form of 40-year loan -- mostly either adjustable-rate mortgages, in which the interest rate changes every so often, or interest-only loans.
But I found one that is no different from a conventional mortgage, save for the longer term. The 40-year loan from LoanStream Mortgage carries a fixed rate and is amortized over the full 480 months. It is available for purchases as well as refinancings, says Dallas regional sales manager Kevin McKnight.
But does a longer term really realize any savings? I asked Adam Neft, a sales manager at GO Mortgage in Columbus, Ohio, to run the numbers on a $200,000 mortgage at 5% interest. Here's what he reported:
On a 30-year loan, the monthly payment would be $1,074. But on a 40-year term, the payment would be $964 -- a monthly savings of $110. That may make a big difference in the short term, but over the decades, the difference in interest payments is staggering.
On a 30-year mortgage, held to term, the borrower would pay $187,290 in interest. The 40-year borrower would pay $263,330 -- a difference of $76,040! Over the same period, the total monthly savings is just $52,800, meaning you'd pay more in interest than you'd save by lowering your monthly payment. Moreover, the biggest chunk of interest comes in the earliest years of a mortgage.
Looked at another way, the total interest paid on the 30-year loan comes out to about 93.5% of the $200,000 borrowed. But on a 40-year loan, the total interest is almost 132% of the loan amount!
Of course, few people actually hold their mortgages for the full term. They either refinance or sell. So it's more likely that those who opt for a 40-year loan will jettison it long before the final payment is due.
Gumbinger agrees that "a refinance at some point is a virtual guarantee," and advises anyone considering a 40-year mortgage to make sure there is no penalty for paying the loan off early. And if there is, make sure you know exactly what it will be.