The Pros and Cons of the Proposed 40-Year FHA
FHA borrowers are one step closer to being able to reduce their monthly payments by modifying their loan term to 40 years.
In early April, the Department of Housing and Urban Development (HUD), which oversees the FHA, proposed a rule change to increase the maximum term for loan modifications from 30 to 40 years.
The proposal will be open to public comment until May 31, 2022 before moving forward.
Forty-year loans wouldn’t be available to new homeowners. The modification is designed to help current FHA borrowers stay in their homes and avoid foreclosure – before they default on their loans. HUD anticipates a 40-year modification option would “prevent several thousand borrowers a year from foreclosure by increasing a borrower’s ability to afford the modified payment.”
That’s because a 40-year term stretches out the time required to pay off the loan, reducing the monthly payment. If you’ve ever compared a 5-year car loan to a 7-year one, you already know the effect a longer term can have on the payment.
Forty-year loan modifications are already available to conventional borrowers with loans backed by Fannie Mae and Freddie Mac and certain USDA borrowers.
Pros and cons of 40-year loan modifications
During the pandemic, many homeowners fell behind on their mortgage payments due to income loss or sudden health expenses. One way to help them prevent foreclosure and get back on track is modify their mortgage to create a lower, more manageable monthly payment.
Current FHA borrowers can only extend the new loan for 30 years, or 360 months. For homeowners that have only had a 30-year FHA loan for a few years, extending the loan out another 30 years may not reduce the monthly payments very much, especially if the modification comes with a higher interest rate.
But by tacking an additional 120 months to the loan term, a 40-year modification can lower monthly payments even further. According to HUD, this could make the difference between borrowers being able to afford their payments or defaulting and heading toward foreclosure.
But there are drawbacks to extending the loan term so long. Forty-year borrowers would make additional interest payments and build equity at a slower rate. In the long run, they’ll likely end up paying more than they would in a 30-year modification or the original loan. And if they want to sell or cash-out refinance, they’ll have less equity to tap into.
HUD points out that the average life of a 30-year FHA mortgage is around 7 years, so it’s unlikely these long-term drawbacks would have much effect on most borrowers.
If enacted, the 40-year loan modification will be a specialized tool that can help certain borrowers get back on their feet – not a magic hammer that can smash all FHA loans into better shape.