With mortgage affordability criteria having tightened dramatically over the past year, how can borrowers get on the housing ladder? For some, longer-term mortgages might be the answer. Here, we examine the benefits and pitfalls of opting for a 35-year mortgage.
Mortgage regulation became significantly tighter following the financial crisis, with the number of individual loan approvals more than halving between January and December 2008 1. Though house prices had stagnated, banks were highly unwilling to risk lending in large volumes.
Since then, through government initiatives like the Funding for Lending Scheme and Help to Buy, approval figures have been climbing back upwards. But between rising prices and fresh new restrictions that recently came into play, they might well be about to take another nosedive.
The Mortgage Market Review is a massive shake-up of the rules that banks and other lenders must follow when granting mortgages. Going forward, mortgage sales will almost always need to be fully advised, and will include rigorous affordability checks that will probe into seemingly innocuous expenses like haircuts or gym subscriptions.
Experts predict that the new rules will make it much more difficult for average borrowers to qualify for a mortgage.
Could a longer mortgage term be the answer?
25-year mortgages have been the tradition for years, and are so common that borrowers rarely even ask about a shorter or longer term. But most mortgage terms can comfortably run from 15 to 35 years, and some lenders will go as low as one year or as high as 40.
Because of the rising average life expectancy and recent increase in retirement age, longer-term mortgages are becoming more feasible for a larger number of borrowers. The longer the mortgage term, the more repayments there will be and the lower each individual repayment will be. Conversely, shorter mortgage terms will entail a lower number of larger repayments.
However, because mortgage interest is compounded (i.e. added to the loan, so that the total loan size increases and accrues yet more interest), the longer the mortgage term is, the more the borrower will need to repay in total.
After a fashion, a 35-year mortgage fills the effective ‘gap’ left by interest-only mortgages, which lost a significant degree of popularity following the financial crisis. Like an interest-only mortgage, the repayments on a 35-year mortgage are smaller and the total principal to be repaid is higher. Unlike interest-only mortgages, however, the capital is repaid by the end of the mortgage term and the borrower owns his or her home outright. Longer-term repayment mortgages are therefore far less risky than interest-only loans.
To give an example…
Let’s say that two average earners in the East of England, earning £42,000 after tax between them 2, apply for a mortgage on an average semi-detached property worth £178,000 3. With a 25% deposit, the total mortgage will amount to £133,500.
A typical APR (annualised percentage rate) for a mortgage is 4.3%. For a 25-year loan, this would leave our example couple a monthly bill of £727. At just over a fifth of their take-home monthly pay, this is quite affordable by pre-MMR standards – however, if they have particularly expensive lifestyles (large amounts of leisure spending, for instance) or a number of other large outgoings (such as childcare or other debts), they might find that their application runs into difficulty.
By stretching to a 35-year mortgage, our applicants can reduce their monthly payments by over £110. Whilst it’s not guaranteed, this might be enough of a difference to merit an approval.
The devil is in the detail, however, and looking at the total amounts repayable, the downside becomes apparent.
With a 25-year term, the borrowers will repay a total of just under £220,000. The amount to repay under a 35-year term is just shy of £260,000 – almost a fifth higher. That’s nearly a full years’ take-home pay; enough to refuel a family car 420 times, take 1,000 trips to a theme park, order 3,600 takeaways or buy 820 Premier League football tickets 4!
So is a 35-year mortgage right for you?
On the face of it, it seems as though a longer mortgage term is the perfect way to meet the new affordability requirements and get on the housing ladder. Of course, it’s not always as clear-cut.
Firstly, as explored, the longer repayment term will eat into your finances for longer and increase the total amount to repay. Secondly, you will repay capital at a slower rate, meaning that it will take longer to build up equity in your home – which could prove a problem if a further house price crash were to happen in the near future.
Then there are lenders’ age restrictions. Many lenders cap the maximum age a borrower can be when their loan matures, meaning that homebuyers in their 30s or 40s may be unable to opt for as long a term as they might like.
As with all things, there is no catch-all solution. The best thing to do is discuss your circumstances and needs with an experienced mortgage adviser, who can help match you to a lender that can help.