by Calculated Risk on 8/22/2005 04:18:00 PM

Reuters reports: Stretching mortgage to 40 years can be risky

"This (40-year) loan product screams of a budget-constrained consumer desperate to get into a home," says Gary Schatsky, a fee-only financial adviser/attorney. "This trend is disturbing to me, especially since it feeds into the growing obsession by consumers to get credit.

"They need to think through this mortgage's implications because in many cases, it will become their children's mortgage," says Schatsky, who is based in New York.

I think a 40 year fixed rate loan is better than an option ARM. But I do agree that they are symptomatic of desperate "budget-constrained consumer[s]" trying to buy a home.

... Bankrate.com, notes that interest rates on 40-year mortgages are generally 0.25 to 0.50 percentage point higher than on traditional fixed 30-year loans. That difference negates some of the benefits of the lower monthly payment.

Here is an example: A $300K 30 year loan with an average Freddie Mac interest rate of 5.8% has payments of $1,760.26 per month.

For the same amount financed for 40 years with a 0.375% higher rate, the payment is $1,687.38. A buyer has to be desperate to pay the higher interest rate for that small reduction in monthly payments.

"This all stems from affordability and borrowers stretching themselves beyond their reach to get into a home they can't afford," says Economy.com's Chen. "What's next, a 50-year loan?"

Recent anecdotal evidence indicates that home price increases are beginning to decelerate, a sign the housing sector is starting to cool.

"When housing cools, so will these loans," Schatsky says. "If a consumer has to take out this loan to qualify for a home, their goal of homeownership needs to be seriously re-evaluated."