40 year mortgages: are they worth it?

At first glance a 40-year home loan’s promise of lower monthly repayments may seem appealing. And with interest rates going up, many borrowers are looking for ways to ease the strain on their budgets. So the lower your repayments the better, right?

Well, it’s not quite so simple.

A 40-year mortgage is a home loan which you pay off over a period of 40 years. That part is obvious. They’re generally harder to find, with most home loans being 15-30 years long. 

They usually result in lower monthly repayments due to stretching out the life of the loan, but will often charge a higher interest rate than their shorter-term counterparts.   

But, as you’re tacking on more time to your loan, interest is applied for longer. This means that you’re likely to end up paying significantly more money by the end of it.

For those with time, like young first-home buyers, the prospect of a 40-year mortgage might not sound so bad if it means lower monthly repayments. Sure, you might finally pay-off your mortgage when you hit your 70s, but you theoretically will have had more disposable income or savings over your lifetime. 

40-year home loans are also attractive to those with cash-flow issues, or those looking to get their foot in the door of a house above their monthly mortgage budgets, simply due to the lower cost of repayments.

Having an extra 10 years on the life of your loan means that there’s more time for interest to accrue. So, the short-term savings you might make with a 40-year home loan could be negated by the extra interest you’ll accrue by adding an extra decade to your loan period. For some, that’s a worry. 

Let’s look at an example of how the length of your home loan affects both your monthly repayments and the overall cost of the loan. 

Monthly repayments

Say Kath borrows $500,000 to buy a house. If she is charged an interest rate of 2.5% p.a., her monthly repayments for a 30-year mortgage would be $1,975. However, for a 40-year mortgage they’d be $1,650 — a difference of $325 per month.

Overall cost of Kath's loan

The total interest Kath will have paid on a 30-year home loan adds up to $211,217. However, with an extra decade on top, a 40-year home loan racks up $291,468. That’s a whopping difference of $80,251 in extra interest. 

Choosing your home loan period is the classic short-term vs long-term dilemma, which you should definitely take your time deciding on.

As 40-year home loans are rare in Australia, it can be hard to choose between the ones on offer. Here are a few tips and things to think about, which might help you make a more informed decision about one of life’s biggest choices.

Consider the flexibility of your budget

When it comes to choosing how interest is applied to your loan, make sure you consider your budget. That is, how flexible are you if your monthly payments increase with the market rates? If the answer is, ‘I’d rather not think about it’, then it might be a good idea to look into a fixed interest rate. 

Otherwise, there are also variable interest rates, which are good for taking advantage of the low interest rates and more favourable market conditions.

Are there any additional fees?

You should definitely consider how your lender treats additional fees. Some will charge for making early repayments, or maybe they’ll have monthly administration fees. Some lenders also charge discharge fees, which are applied when you exit your loan or pay off your balance in full. 

Before you make your final decision, have a read through the loan’s product disclosure statement (PDS), so you’re aware of any extra fees that you’re agreeing to pay.

Variable rate home loans:

• Rate could rise or fall depending on the market
• You have the option to make extra repayments to pay off your loan sooner and save on interest

Fixed rate home loans

• Lock in your whole home loan’s rate (or just a portion of it) for a set period of time
• Ensures consistency in repayment amounts, making it easier to budget 

Low-doc home loans

• For those who are self-employed or don’t have the necessary proof of income documents
• Higher interest rates to offset the risk for lenders 

Package home loans

• Usually involves packaging your home loan and other financial products together 
• Can come with interest rate discounts and additional incentives, but typically also have an annual package fee which can be several hundred dollars