Every now and then something happens to shift the status quo. For investors, the important thing is to identify these shifts early and understand how they will impact the investment landscape in the future.
One big shift that is occurring right now in Australia is the advent of the 40 year mortgage.
Traditionally, Australian mortgages have been set to a standard 30-year term. Recently, lenders have started shaking things up with the introduction of 40-year mortgages – yes an additional 10 years added to a loan term. This shift is a clear response to the financial pressures Australians are under today, evolving demographic trends and competition driving change in the lending market.
Key Factors Behind the Shift:
- Affordability: Rising property prices in Australia have made housing less accessible, particularly in major cities like Sydney and Melbourne where the average house price exceeds $1M. (CoreLogic, November 2024)
- Cost of Living: Wage growth has not kept pace with inflation and the rising cost of living, impacting household budgets and increasing financial strain.
- Regulatory Alternatives: Extending loan terms offers lenders a way to address borrower needs while working within regulatory constraints.
- Demographic Trends: Australians are working and remaining financially active later in life. For example, the average retirement age rose to 64.8 years in 2022, up from 53.5 years in 2000. (ABS)
- Demand: Banks make profits from lending money, so the more money they can lend the more profit they make. Increasing the length of the loan enables banks to lend borrowers more money and increase the number of people that can qualify for a loan, thereby increasing their profits.
Regardless of the bank’s motivation, one clear implication of this shift is that when people can borrow more from major banks they tend to be able to pay more for properties. Also, with more people qualifying for loans, competition is likely to heat up amongst those seeking to get on the property ladder. Inevitably, this will drive up property prices.
So, the question that investors are invariably asking us is, “is a 40 year mortgage right for me?”
At OpenCorp, we believe the function of a 40-year mortgage depends on the investor’s goals and circumstances. Investors should carefully consider the potential trade-offs and consult with property investment professionals to understand how it fits in your investment strategy. Here is a wrap up of provisions to consider:
Pros for Investors:
- Lower Monthly Repayments:
- Spreading the loan over 40 years reduces monthly repayment amounts, which may improve cash flow for investors managing multiple properties.
- Example: $600,000 loan at 4% interest (principal & interest):
- 30-year term: $2,864.49 per month
- 40-year term: $2,573.71 per month
- Monthly savings: $290.75
- Extended Financial Planning:
- A 40-year mortgage may align with the needs of those who plan to work longer and incorporate property investment into long-term financial strategies.
- Improved Serviceability and Investment Potential:
- Lower repayment obligations may help investors meet lender serviceability requirements, enabling access to larger loans or additional properties.
- For some investors, this may be the difference between buying now in a growth market or waiting years to buy a property and ultimately paying more for an inferior property (after the growth has occurred).
- Opportunity for Interest-Only Extensions:
- Some lenders offer extended interest-only periods (e.g., up to 15 years), which could further enhance short-term cash flow and return on investment (ROI).
Cons for Investors:
- Increased Total Interest Costs:
- Extending the loan term significantly raises the total interest paid over the life of the loan.
- Example: For a $600,000 loan at 4% interest:
- 30-year total interest: $433,215.52
- 40-year total interest: $637,396.40
- Difference: $204,180.88 more in interest with a 40-year term.
- Slower Equity Growth:
- Equity builds slower when you have a 40-year loan because you have less money paying down your balance every month.
- Example:
- For a 30-year loan, you would have 26.7% equity after 10 years under the loan terms discussed in the earlier example.
- With a 40-year loan, you would have 12.3% equity by the same point.
- The slower equity growth in the 40-year mortgage is due to lower monthly payments that allocate less to the principal and more to interest in the early years. This may impact an investor’s ability to leverage equity for future investments.
- That being said, the lower repayments leave you with more cash in your pocket, which you could save in an offset account thereby reducing your interest bill while still having access to the cash should you need it.
- Market Volatility Risks:
- Locking into a longer-term loan could expose investors to future changes in interest rates or regulatory shifts that may impact profitability.
- Example: Interest Rates
- If interest rates rise on a variable 40-year loan, repayments could significantly increase, straining cash flow and reducing profitability. Conversely, locking in a fixed rate might prevent taking advantage of future rate cuts. Nonetheless, 30-year loans are also in the same situation.
- Exit Strategy Complications:
- Holding a higher balance loan for longer may reduce exist strategy options. Of course, this should be considered against the benefits of holding more properties in the short term to capture growth opportunities.
- Example: Debt Consolidation Challenges
- In a market decline, selling the asset might not cover the remaining loan balance, leaving the investor with residual debt and limited options to restructure finances.
Strategic Considerations
When considering a 40-year mortgage, it’s essential to incorporate it into a broader strategy tailored to your personal goals and circumstances. While there are definitely higher costs associated with longer loan terms, these must be assessed against the benefit of being able to get into the market sooner. Further, starting with a 40 year mortgage doesn’t mean that you cannot refinance and reduce the loan term at a later date when your income levels change.
Remember, a change like this is likely to result in an increase in property prices. If interest rates drop in the future, the impact will be multiplied. Smart investors understand that there are two sides to every coin, and those investors that can capitalise on these changes to hold more property during a growth phase (within their ability to service loans without impacting their lifestyle or taking undue risks) will ultimately make substantial profits from price appreciation in the coming years.
Disclaimer: This article is intended for general informational purposes only and does not constitute professional financial, legal, or tax advice. OpenCorp does not hold an Australian Financial Services License (AFSL) and is not authorised to provide financial advice. We strongly recommend seeking tailored advice from a licensed financial advisor, tax professional, or accountant before making any investment decisions. OpenCorp is not liable for any actions taken based on the information provided in this blog.
