Should Investors Start Using 40-Year Mortgages?

News that the Federal Reserve is about to start cutting interest rates has electrified the real estate industry, with homeowners and investors eagerly waiting to see how low rates will go. However, there’s some sobering news for those expecting a return to 3% and 4% mortgage rates: It’s not likely to happen, at least not anytime soon. More likely, as the New York Times predicts, we will settle around a 5.5% to 6% rate, which, in addition to the chronic lack of affordable homes—which doesn’t look like it’s ending anytime soon either—means homeownership will likely remain out of reach for many. 

A possible solution? The 40-year mortgage.

John Hope Bryant’s Suggestion

An investor and former advisor of both the Bush and Obama administrations, John Hope Bryant is chairman and CEO of Bryant Group Ventures and The Promise Homes Company, the largest minority-controlled owners of single-family rental homes in America. He is a big proponent of the 40-year mortgage to help curb unaffordability. Although such mortgages have been touted before, they have yet to replace the more traditional 30-year mortgage, partly due to the greater payback over time to borrowers and riskier elements such as adjustable rate periods and balloon payments often baked in.

In an interview with Fortune, Bryant says that a 40-year mortgage could make homeownership accessible to more borrowers with a few adjustments to the current model. His key changes would be:

• Subsidizing the rate between 3.5% and 4.5% for first-time homebuyers after they complete financial literacy training.
• Subsidies would be capped at $350,000 for rural areas and $1 million for urban.
• There would be no cap on age.

“Why discriminate against somebody because they’re older? That’s crazy,” Bryant said. “Let them buy that house just like a 20-year-old would, and who knows? Maybe they’ll surprise us and live to 100.”

A Short-Term Fix

Bryant sees the lengthier mortgage as a short-term solution, saying: “The 40-year mortgage, in and of itself, is a Band-Aid. The surgery that fixes this problem is long-term inventory.”

Aware that many people are wary of being saddled with debt for four decades, Bryant offered: 

“Does the market have a better idea for solving affordability and broad access, still rooted in free enterprise and capitalism? We’re not talking about socialism or communism or some crazy stuff … If somebody has a better idea, I’m all ears. I’m sure that when car loans went from three-year and four-year terms to four- to eight-year terms, I’m sure that people said that’s crazy.”

40-Year Mortgages Are Routinely Used in Loan Modifications

As Bryant admits, the 40-year mortgage is hardly a new concept. In fact, as of May 8, 2023, the Federal Housing Administration (FHA) approved them as part of a loan modification package to reduce a homeowner’s mortgage payments by at least 25%. However, even HUD acknowledged that 40-year mortgages would only be practical with a sizable interest rate reduction.

“While rising interest rates may keep the 40-year loan modification from providing significant payment reduction, HUD believes that rising interest rates make the 40-year loan modification more critical in circumstances where the 30-year loan modification does not sufficiently decrease the monthly payment to an amount that the borrower could afford to retain their home,” a final ruling from HUD read. It adds weight to Bryant’s suggestion that rates be subsidized for first-time homebuyers.

How 40-Year Mortgages Could Help Investors

So, what could it all mean for real estate investors? Here are some key potential benefits.

More cash flow for small multifamily units

Rookie real estate investors could benefit from 40-year mortgages aimed at first-time homebuyers when they purchase a two-to-four-unit property using an FHA loan. They could use their tenant’s mortgage payments to help pay their mortgage. A 40-year mortgage would increase their cash flow, which they could use to either pay down their principal or save toward the down payment on another investment.

Tax benefits

Though every investor’s tax strategy might differ, and a real estate-savvy accountant can help you decide which is best for you, a lengthy mortgage repayment period could increase your mortgage interest deduction, thus reducing your annual taxable income.

Alternative loan structures can be included in your 40-year mortgage

Depending on where you are on your investment journey, a 40-year mortgage can offer different payment strategies to maximize your income or alleviate your payment amount, giving you greater flexibility throughout the loan as your goals change. For example, you could incorporate an adjustable-rate mortgage (ARM) that provides an initial lower fixed rate before becoming variable to make your loan payment more manageable.

Where to Get a 40-Year Mortgage

Most lenders do not offer 40-year mortgages for new borrowers as “qualified mortgages,” meaning they don’t follow the same set of rules created by the Consumer Financial Protection Bureau (CFPB) as 30-year mortgages. Also, 40-year mortgages are not conforming loans, which means they don’t follow Fannie Mae and Freddie Mac’s rules for conventional loans, although 30-year loans can be lengthened through loan modifications for borrowers facing financial difficulty.  

There are currently two ways to get a 40-year mortgage via a modification. These are:

• FHA 40-year mortgage: A 40-year loan modification program for existing FHA borrowers
• Fannie Mae or Freddie Mac Flex Modification: Conventional mortgages backed by Fannie Mae or Freddie Mac can be extended to 40 years to reduce the payment by 20%.  

Banks That Offer New 40-Year Mortgages

Only a few banks currently offer 40-year mortgages for new homebuyers. These include:

• Carrington Mortgage: Carrington Mortgage offers fixed and adjustable rates, interest-only, jumbo loans, refinances, and cash-out refinances for 40-year mortgages.
• Needham Bank: Needham Bank offers adjustable rates only for 40-year mortgages.
• Newrez: Formerly Caliber Home Loans, Newrez offers interest-only payments for the first 10 years on its 40-year home loans.
• OneUnited: OneUnited, a 50-year-old Black-owned bank, offers 40-year multifamily mortgages in Boston, Los Angeles, or Miami. The bank aims to help investors add affordable multifamily housing to communities hardest hit by the housing crunch. It offers loans up to $7 million.

Final Thoughts

As John Hope Bryant rightly said, most 40-year mortgages will not be a cure-all for borrowers hoping to take them back to COVID-era loan payments. However, the available products could offer additional cash flow for new investors buying owner-occupied small multifamily buildings, using house hacking to jump-start their investment journey. 

For investors looking to scale their portfolios, there are not many options similar to OneUnited’s multifamily product on a national scale. Considering the current housing crisis, there is surely a gap in the market for mortgage products amortized for more than 30 years to help compete with high rates and low inventory, even if they incorporate balloon payments before the end of the full amortization period or have interest-only or ARM options.

Most investors can attest that the first few years after buying an investment are usually the toughest, as you stabilize the building, complete repairs, and remove bad tenants. That’s when low monthly payments are most needed. An interest-only or ARM period would facilitate that. Once a building is profitable, owners then have options to sell, refinance, or accelerate their paydown, making a 40-year mortgage an invaluable investment and homeownership asset.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.