Risky home loans - what to avoid

We expose the traps of new types of loans, including 40-year mortgages and no-deposit home loans.
 
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  • Updated:5 Jan 2006
 

02.40-year mortgage

CHOICE crunched the numbers and found that extending a mortgage to 40 years doesn’t make it much more affordable, and costs you many thousands of dollars more in the long term.

  • On a $250,000 loan with an interest rate of 8%, your repayments would be about $100 per month cheaper: $1738 per month over 40 years instead of $1834 over 30 years.
  • But it’ll cost you. Over the 40 years you’ll pay nearly $585,000 on the $250,000 loan in interest alone, which is more than double the amount borrowed — and about $174,000 in interest more than you’d pay over 30 years.
  • If you borrowed $400,000 you’d pay $935,000 in interest over a 40-year term, about $278,000 more than over a 30-year term. Your repayment reduction is just $150 a month.

Comparison of repayments and interest of different mortgage terms

Mortgage terms table
Taking out a 40-year mortgage because you can’t afford the monthly repayments on a 30-year one doesn’t just cost you thousands more in interest. It’s also extremely risky and will backfire if interest rates go up.

An interest rate increase of just 0.5% would eat up the difference between the repayments: a $250,000 loan at an interest rate of 8.5% over 40 years would have a minimum monthly repayment of $1833 — just $1 less than the minimum repayment at 8% over 30 years.

It’s sensible to have an interest rate buffer of at least 2% when you buy. For example, in early 2002 banks’ standard home loan interest rates were 6%. By December 2007, they were 8.5%.

If you’d borrowed $250,000 in 2002 on a 30-year loan, you’d have started out with a minimum monthly repayment of $1507. But in December 2007 you would have been paying $1931 per month, and even more from January 2008 onwards, after major banks lifted their rates. If you were stretched to the limit to meet repayments in 2002, how much harder would it be now?

CHOICE looked at three financial institutions offering 40-year mortgages:

  • Savings & Loans Credit Union
  • Police & Nurses/Nurses First Credit Society
  • GE Money

On the upside, all three allow extra repayments, so you could take out a 40-year mortgage and pay it back over a shorter term, such as 30 or even 15 years, without any penalty.

CHOICE verdict on the 40-year mortgage

It makes sense to repay your home loan as quickly as possible. Extending a mortgage to 40 years doesn’t help much with affordability, as the monthly repayments aren’t much lower.

It can also get you into serious trouble if you budget to the limit on a 40-year mortgage; even a small rise in interest rates will hurt you badly. The only winner is the lender, as you’re paying them much more in interest.

 

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