Created by: John Fitzsimons | 3 April 2019

Why stretching your mortgage term is dangerous

While mortgages have traditionally been offered over 25-year terms, this has started to change in recent years.

According to data from Moneyfacts, the number of mortgages with a maximum mortgage term has jumped from 1,118 to 2,221 since 2014. There has been an even more significant jump in the number of products with a maximum term of 40 years, to 2,604 from 1,096.

Why go for a longer mortgage term?

For many borrowers, the allure of a longer mortgage term is very simple - it makes it much easier to afford the monthly repayments.

Your mortgage repayments are determined by three main factors - the size of the loan, the interest rate and the mortgage term. By taking a longer period in which to pay off that loan, the size of the monthly repayments needed in order to pay off that balance falls.

Let’s take an example. If I borrowed £200,000 over 25 years on a mortgage with an interest rate of 3%, that would mean monthly repayments of £948.

But bump that mortgage term up to 40 years and that monthly repayment plunges down to £716.

A question of affordability

This isn’t just borrowers wanting an extra couple of hundred pounds a month to spend as they like though. Since the Mortgage Market Review, which came into force in 2014 in the wake of the financial crash, mortgage lenders have been forced to be much tougher in working out whether a borrower can truly afford the loan they are looking for.

To do this, they need to assess not only how comfortable a borrower will be in meeting the current repayments, but also include calculations based on interest rates rising.

As a result, plenty of borrowers have had to go for longer mortgage terms than they might like to, simply so that they can pass a lender’s affordability tests.

Why going longer costs you more

While a lengthier mortgage term will reduce the cost of your monthly repayments, because it takes you longer in order to clear the balance, you will end up costing more overall.

So returning to our example above, that £200,000 mortgage over a 25-year term will cost a total of £284,527. In other words, almost £85,000 in interest payments.

But going for a 40-year term will see that overall cost jump to £343,665. That’s a whopping £143,665 in interest charges, almost £60,000 more than with the shorter mortgage term.

The difficulty in building up your equity

It would be a mistake to think this is the only financial cost to a longer term though. As you pay off your mortgage, you build up the amount of equity you own in the property. This is essentially the difference between the overall value of the property and the outstanding mortgage, and acts in place of a deposit when you come to remortgage.

The more equity you own, the smaller the loan-to-value will be on any remortgage deal, and that should mean lower interest rates too.

However, because a longer term means it will take you longer to build up that equity, that means you will be stuck on higher loan-to-value mortgage deals - and with them higher interest rates - than would be the case if you’d gone for a smaller mortgage term.

I can’t move!

There is a further concern here, in the shape of falling house prices. If you only have a small amount of equity when you purchase a property, and house prices fall, you are in danger of dropping into negative equity.

This is where the outstanding mortgage is higher than the value of the property. So for example, let’s say that you bought a property with a 5% deposit, but a year later the value of that home has dropped by 10%. You’ll then be in negative equity.

This is a worry for a couple of reasons. Firstly, it makes it near impossible to remortgage to a new, cheaper deal, as you’ll need to stump up some form of deposit. Secondly, it makes it tricky if you want to move house, as the money you get for selling the home won’t be enough to pay off the existing mortgage.

People on shorter mortgage terms aren’t immune to negative equity, of course, but homebuyers with only a small deposit and lengthy mortgage term are undoubtedly more at risk.

Do I want to be paying off my mortgage in retirement?

The final consideration is what age you will be when you finally clear the mortgage in its entirety.

A longer mortgage term obviously means you’ll be much older - potentially even in retirement - by the time the mortgage is paid off in full. Do you really want to be worrying about mortgage payments even after you’ve finished work? If not, a lengthy mortgage term may not be for you.

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