27th September 2007

Lower repayments using 40 year loan terms

How can mortgage providers improve affordability for home buyers? One answer is to increase the maximum loan term. Currently for most Australian financial institutions the maximum loan term is 30 years. However, in both the US and the UK it is not uncommon to offer a 40 year mortgage.

According to the latest figures from the Australian Bureau of Statistics the level of housing affordability has not changed in Australia over the last 24 months. However the impact of the property boom at the beginning of this decade has left a big gap between housing prices and consumer spending power. The consumer price index (CPI) has increased by an average of 3% p.a. over the last four years – barely comparable to the increase in house prices of 10% p.a.

As expected, 40 year mortgages are attractive to low income borrowers seeking an entry point to the property market. Properties that were out of reach with a 30 year mortgage can suddenly become affordable when the repayments are spread over an extra 10 years.

Surprisingly the international experience suggests that
40 year mortgages are now also the home loan of choice in the luxury home market. These products have attracted home buyers at the high end of the housing market. These are people wanting to leverage themselves into homes in the next price bracket or who simply have better things to do with their cash flow than pay off their own home.

Product initiatives that could improve affordability for Australians would seem appropriate in the current rising rate environment. The recent retraction in prices across some housing markets has restored hope for some buyers, but this may be short-lived given the recent rate rise and the lingering threat of a future rate rise. But there are two sides to the 40 year mortgage story.

Pros and Cons

The primary advantage of a 40 year mortgage stems from simple calculations. By extending the repayment term by an extra 10 years, the monthly repayments become more affordable. For example, on a $250,000 loan, the repayments on a 40 year mortgage are approximately $100 lower per month than the repayments on a 30 year mortgage. This reduction in payments is equivalent to the reduction in repayments resulting from a 0.63% fall in interest rates.

Moving the mortgage term from 30 years to 40 years translates into lower monthly repayments of the principal. This not only means that the equity in the home is built up at a slower pace, but it also means a significant difference in the cost of borrowing if the loan is in place for the full term. In our example, the 40 year loan costs $150,000 more than the 30 year loan, over the full life of the loan. Clearly there is an impact on an individual’s longer term financial goals that need to be weighed against the advantages of the property purchase.

Advantages Disadvantages
Lower monthly repayments Slower equity growth
Increased borrowing power Paying more interest due to longer term
May increase overall housing debt
Table 1 Advantages and Disadvantages of a 40 year model

Does Australia need a 40 year mortgage?

With Australians’ appetite for property remaining strong and concern over household debt rising, this product is likely to evoke strong arguments on both sides. In recent years innovation in the Australian mortgage market has attracted criticism. Line of Credit products, low doc loans and reverse mortgages have placed the industry under intense scrutiny because they have effectively changed the risk profile of home lending. Introducing 40 year mortgages will not only add to the cost of home ownership, but could arguably increase the risk to first time home owners. A 40 year mortgage will materially extend the time it takes for them to build up equity in their own home.

But how real is this risk? Borrowers rarely take a home loan with the intent of paying it off over the full 30 year term. These days the average life of a mortgage is less than 7 years. After this time people typically trade up to a bigger property or restructure their loan to accommodate their changing circumstances. Therefore the cost impact of a 40 year mortgage as opposed to a 30 year mortgage is likely to be minimal and for many, validated by the opportunity to purchase a property that would otherwise be unaffordable.

Best regards
Iain Pepper


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Iain Pepper
Head of Lending

Iain Pepper is a Vice-President and the Head of Lending for the La Trobe Group.Read full profile here.

La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 145 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.

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