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By BankingMyWay Staff

Creative financing options for homeowners have come under enormous scrutiny in light of the recent housing crisis. Millions of homes are in foreclosure, with many of them the result of adjustable rate mortgages (ARMs) resetting payments beyond the reach of homeowners. These creative mortgages were used to stretch the buying power of homeowners, and in many cases, it was stretched far too thin.

Some homeowners looking for increased buying power without the risk of adjustable rates have now turned to 40-year mortgage products. A 40-year mortgage offers the safety and predictability of a fixed-rate mortgage with lower monthly payments than a 30-year mortgage. For those who just barely miss qualifying for a home they desire, a 40-year mortgage may be able to close the gap.

Stretching a mortgage out for an additional 10 years does not, however, produce as much monthly savings as you might expect. Consider this example: A $200,000 mortgage financed for 30 years at a fixed rate of 5.5% would carry a monthly payment of $1,135.58. The same loan financed over 40 years at the same interest rate would carry a monthly payment of $1,031.54, a difference of only $104.04. Use BankingMyWay’s Mortgage Loan Calculator to crunch the numbers for yourself.

In truth, however, 40-year mortgages do not typically offer the same interest rate as 30-year mortgages. In order to compensate for having their money tied up for longer and exposed to greater risk, banks may charge up to .5% higher interest. In the previous example, a 40-year mortgage loan at 6% would carry a monthly payment of $1,100.43, which would equal a savings of only $35.15 over the 30-year mortgage.

For that meager monthly savings, homeowners pay a high price in total interest paid. Should a homeowner stay in the home for the life of the loan, the difference between 30-year mortgage and a 40-year mortgage in total interest paid even when the interest rate is the same equals $86,333.87.

Of course, most homeowners will not stay in their home for 30 or 40 years. Those who move out early, however, will also sacrifice considerable equity when choosing a 40-year mortgage. Because payments are spread out over a longer period, equity builds more slowly with 40-year mortgages. With same $200,000 and 5.5% interest rate, homeowners would sacrifice $16,695.26 in equity at the 10-year mark by choosing a 40-year mortgage over a 30-year mortgage.

Despite their drawbacks, 40-year mortgages can be a helpful home-buying tool for those who use them wisely. A professional just starting out in her career, for example, may be able to get into a slightly pricier home using a 40-year mortgage. As her income grows, she can refinance into a mortgage product that allows equity to grow more rapidly.

The danger with using a 40-year mortgage to stretch buying power is getting into a more expensive home than you can truly afford. If the housing crisis has proved nothing else, it’s the lesson that just because you can get a mortgage for a home doesn’t mean you should. If housing prices continue to fall and you are stuck holding the bag on a 40-year mortgage with no equity, the next home foreclosure could be yours.

— For more ways to save, spend, invest and borrow, visit MainStreet.com.