Increasing numbers of mortgage borrowers are electing to go for a 40 year mortgage term instead of the traditional 25 – but is it a good or bad idea?
Latest figures show the cost of buying your own home is cheaper in the long run than renting and, of course, you have a very valuable asset at the end of the term.
But first of all there’s the question of how you get there.
Property prices continue to rise across the country, way ahead of real wage growth, so affordability is a real problem when looking for a mortgage to buy your dream home.
Millions of would-be buyers looking at a traditional 25 year loan are finding that the numbers just don’t add up for them.
It’s a decade since the financial crisis forced the regulators to look at the rules surrounding lending after irresponsible lending by firms like Northern Rock with a 115% deal helped lead to the near collapse of the UK finance system.
The Financial Conduct Authority (FCA) ran its Mortgage Market Review in 2014 which considerably tightened lending criteria and made mortgages much more difficult to get hold of.
Now, rather than focusing on how much you earn, a lender will look closely at your income and expenditure and your creditworthiness to decide of you’re a safe bet to lend to.
But there is a way to close the affordability gap – by extending the mortgage term by another 15 years and instantly reducing the monthly repayments to a much more affordable level.
Recent research by Santander suggests that almost half of all buyers would consider a 40 year term if it gave them their first foot on the property ladder.
A separate study has revealed that almost half of all mortgage providers are now happy to offer extended terms.
Santander suggests that going for the 40 year deal over the standard 25 could help no fewer than 3.25 million buyers to take that first step.
Not all good news
But it’s not all good news.
Extending the life of the mortgage means you will be paying interest on the loan for 15 years longer, ending up paying considerably more than the cost over 25 years.
A £150,000 mortgage over 25 years at 2.5% interest gives monthly mortgage repayments of £795. Extend the term to 30 years would drop the repayments to £593. Add another 10 years and the figure drops to around £495 – £300 a month less than the 25 year term.
But then you have to factor in how much interest you will end up paying.
Extending from 25 to 40 years means you will end up paying more than double the amount of interest – around £87,400 as opposed to £40,700, according to independent brokers L & C Mortgages.
As short as possible
Director David Hollingsworth said: “The rule of thumb is to keep the mortgage term as short as possible, as it will help keep the overall cost of the mortgage down.
“However, it’s understandable that borrowers, especially first-time buyers, will be keen to give themselves some breathing space when they first take out their mortgage.
“That doesn’t mean that they can’t keep that position under review. Once they come to re-mortgage at the end of the current deal, there is absolutely nothing to stop them restructuring the mortgage onto a shorter term.”
The other downside to an extended term is the simple mathematics of when the borrower will be able to repay the loan in full.
The affordability rules have boosted the need for larger deposits to an average £31,000, increasing the average age of a first-time buyer to 33 as they are forced to save first before taking on their loan.
The delay means they could be picking up their old age pension for some years before the loan is repaid.
Figures from the Prudential show that 1 in 5 Brits are already retiring with £34,000 worth of debt even before the extended mortgage terms start to make their presence felt.