Do 35-year home loans help or blow out your costs?
The length of your mortgage is perhaps something you’ve put on the backburner, along with how much your energy bill will come to after this humid summer and whether you might be overdoing it with too many streaming services.
Problems for future you, I get it.
For some though, the length of their home loan has become top of mind and that’s mostly because they want a bit of breathing room from the constant interest rate hikes set in motion by the Reserve Bank last year.
With higher interest rates on home loans generally, many homeowners and some would-be mortgagees are surely wondering if a longer home loan term might ease the burden of heftier repayments.
In other words, the standard 25-year or 30-year loan issued by most lenders has repayments that are perhaps too big a mountain for some right now.
Fair enough. Life in 2023 isn’t cheap, we’re all sensing that in one way or another.
So with the recent news that some providers are indeed offering loan terms of 35 and 40 years, borrowers are surely considering the prospect. After all, a lengthened term should provide a short-term gain – lower repayments! It’s not a bad thought, but isn’t it risky?
Our banking expert Peter Marshall shared some thoughts with me on this and suggested that yes, this longer home loan plan could suit some people by bringing down their immediate costs. But he also reiterated that there’s risk involved if you don’t fully understand the implications of teasing out the length of time.
“There certainly is some risk, so you need to go in with your eyes open and with a plan,” says Marshall. “If it matches up with your life plan then it can work, where perhaps you can’t afford higher repayments now but down the line you might be able to.
“Maybe you can ramp up later to pay it off faster, or in fact refinance.”
A longer home loan calls for a solid life plan
Marshall suggests that someone who has a life plan, say a working professional who foresees their income increasing over time, might be in a good position to try such an approach. So while they might benefit from lower repayments in the immediate term, they could change course after 10 years or so to avoid the overall impact of paying a lot of interest on a large amount over time.
“In this regard it’s not a bad option and it’s always good for homeowners to have options available to them,” he says.
Another piece of advice Marshall offers is that there are both budget and tax implications for someone taking on a loan for this extended period of time, potentially tying them to the commitment into their retirement years. That’s where some financial advice can be very important.
Consider all this from a pure numbers perspective: there can be a significant difference in interest paid when you start adjusting the loan term.
For example, on a $600,000 owner-occupier principal and interest loan at 5.5% interest rate over 25 years, a person’s monthly repayments are going to be about $3,685. The total over the course of the loan equates to $505,357.
A similar 30 year loan ends up giving you smaller repayments of around $3,407, but then your total interest paid goes up to $626,424.
Now the fun starts. If you increase the loan term to 35 years, yes, your repayments fall to just $3,222 but the total interest paid over those 35 years rises significantly to $753,281.
And just for the exercise, on 40 years your repayments plunge to just over $3000 but you’re looking at about $885,418 in total interest paid.
So these differences look weighty.
But keep in mind, as Marshall says, if you’re expecting to be in a better financial position later on in life, then the overall paid interest projection shouldn’t worry you as much. Indeed this scenario, limiting the immediate impact on your budget, could be far more attractive right now.
As always with money, lengthening your home loan beyond the norm isn’t a one size fits all option. Think of it like your many streaming services – you might prefer the one that gives you the latest Star Wars content and that suits you right now. But as time passes, you may find that your appetite for actually having a mortgage so long drifts out to a galaxy far, far away.