As borrowers stretch to meet mortgage payments, more lenders are adding 40-year products to their repertoires. That includes 40-year fixed-rate mortgages, as well as a range of balloon and adjustable-rate loans with 40-year amortization.
Like interest-only mortgages (IOs), 40-year loans lower the borrower's monthly payments. But the 40-year products avoid the payment increases that IO loans see when principal payments begin, lenders say. In addition, at least some of the payment goes toward the principal.
The California Association of Mortgage Brokers (CAMB) predicts that 40-year fixed-rate loans will be an important option this year. Rising interest rates and a shortage of affordable housing will drive demand for the product, according to the Sacramento, Calif.-based trade group. CAMB predicts that 30-year fixed-rate interest rates will reach almost 7% and that housing affordability will continue to be a critical issue in California, even though home prices are expected to stabilize.
The group's fourth annual survey indicates that a majority (60%) of its members believe that 40-year fixed loans will be more economical for home buyers this year. More than 70% of survey respondents believe that while alternative loans may be a solution for some, it can be risky for others.
Consumer misunderstandings
Many IO borrowers don't realize they'll be socked with big monthly payment increases, says John Marcell, CAMB president and a broker who owns Better Mortgage Brokers Inc. in Upland, Calif. Adjustable-rate IOs often offer rock-bottom start rates, or teaser rates, for the loan's first few months. Many consumers don't understand that it's only an introductory rate and are surprised when their payment jumps.
‘Alternative loans make the dream of homeownership a reality for some consumers, but it is important to realize they are not for everyone and there can be pitfalls,’ Marcell says.
A 40-year fixed-rate mortgage, on the other hand, offers long-term stability with no surprises, as well as at least some principal payments. Interest rates for the products are only about an eighth of a point higher than rates for 30-year fixed-rate loans, he adds.
Lenders have answered consumer demands for lower payments, he notes, saying he knows of about 50 wholesale lenders offering the loans. In fact, he adds, some lenders are considering even longer terms.
‘I don't see anything wrong with going long,’ Marcell says.
Fannie Mae buying the product
After testing the 40-year product with 22 credit unions, Fannie Mae announced last June that it would buy the product from its approved lenders.
‘Based on our feedback, we ascertained that this would be a product that would be appealing to borrowers,’ says Sandra Cutts, a Fannie Mae spokesperson. ‘The product is attractive to those borrowers who are more financially conservative and first-time homeowners looking to make payments a bit more manageable.’
The company decided to drop the pilot and begin buying the product because rates are beginning to tick up, home prices in many areas are posing affordability challenges to moderate-income buyers, and its lenders have asked the company to buy the loans.
Although it's too soon to tell how the product is faring, some consumers find the lower payments attractive, Cutts says. However, although payments are lower, rates are 0.25% to 0.375% higher than for 30-year loans.
‘The 40-year has its pros and cons,’ she notes. ‘It's not for everyone.’
The regulatory impact
Increased regulatory pressures will prompt 40-year products to become more common, predicts Gary McCann, executive vice president at Astoria Federal Savings in Lake Success, N.Y. As banks tighten underwriting standards for IO loans, borrowers who no longer qualify for those mortgages will opt for 40-year products.
The lender has offered ARMs with 40-year amortization for at least 10 years, he says. The loans, especially 5/1 ARMs, were very popular, taking about 40% of applications until the rise of IO loans. Holding loans in portfolio, the Long Island-based thrift originates through retail offices in New York, and through wholesale and correspondent channels in most states.
The longer amortization products also offer an advantage to subprime borrowers. While both IO and 40-year loans lower payments, some subprime borrowers don't qualify for IOs due to stricter underwriting guidelines, points out Delta Sonderman, product manager for HSBC Mortgage Services based in Charlotte, N.C. Plus, if home price appreciation slows, as it is in some markets, the homeowners paying principal may be in a better position.
At the start of the fourth quarter, HSBC Mortgage introduced a 40-year fixed, and a 40/30 balloon, as well as several ARM products with 40-year amortization, for a total of eight 40-year products.
While it's too soon to know which of those products is doing best, the company is pleased with their performance, Sonderman says.
‘We saw it as an alternative to IO or option ARMs,’ she says. ‘We added it because we're very optimistic about it. It's a good addition to our product mix.’
Lenders with broad product lines typically offer 40-year amortization, with the 40/30 balloon being especially common, she adds.