5MF Issue 9: Home Financing

In the US, the 30-year, fixed-rate mortgage is so strongly linked to homeownership that most Americans can’t imagine financing a home any other way. Yet, the vast majority of the world doesn’t use this model.

In fact, the 30-year mortgage as we know it is relatively new, appearing only in the years after World War II to support borrowers who couldn’t pay back shorter-term loans. Its origin is founded in the federal government’s good intentions: single-family homeownership is a cornerstone of the American Dream, after all.

Yet, no one predicted that supporting that dream would simply push the problem down the line. Decades later, millions of Americans still find themselves locked into mortgages they can’t afford.

How did we get here?

A Brief History of the American Mortgage

Until the Great Depression, financing a home (or buying land and building a home) was strictly the business of banks and their customers, with no mortgage insurance or other involvement from the federal government. Costs to build were low, starting at $2,000 (about $62,000 today) for a one-story, 2-bedroom colonial cottage. The cost to buy was, on average, around $6,000.

Buyers would put down 50% of the home’s cost and borrow the rest on a three- to ten-year term, paying only interest until the term ended. At that point, they could either repay the loan in full with a balloon payment or refinance the loan.

(This model, or one similar to it, is still used in many countries today, including Sweden and Canada.)

The Great Depression changed everything. People couldn’t afford to make their final balloon payments. Strapped lenders refused to refinance, borrowers defaulted, banks repossessed and resold homes, and values plummeted. “The 50% loan-to-value built into mortgage structures wasn’t enough to absorb the collapse in house values,” Marc Rubinstein at Net Interest explains. 

In 1933, the federal government stepped in. The Home Owners’ Loan Corporation purchased defaulted mortgages and, to make repayment easier on drained Americans, reinstated them with 15- to 20-year, fixed-rate, fully amortizing mortgages that resemble today’s. It worked. Homeownership rose steadily, and in 1948, the maximum term limit on a loan was raised to 30 years to encourage the trend.

Mortgage Assistance Meets Immediate Needs But Has Long-Term Repercussions

?Despite efforts to put these mortgages back into the oversight of private lenders, the decision to involve the government to prop up mortgages proved difficult to reverse. Fannie Mae, Freddie Mac, and the FHA all exist thanks to efforts to provide mortgage insurance and manage this completely new private-public model.

Its imperfection is clear: whenever enough borrowers struggle to pay off their American Dream mortgages, the government pivots to help. During and after the mortgage crisis of the late 60s, Fannie Mae’s mortgage purchase permissions were expanded to include conventional mortgages, Freddie Mac was created to buy mortgages from the thrift/savings and loan industry, and both had an implicit guarantee of a government bailout if they ran into trouble. Securities made their first appearance during this time, and the government passed necessary acts to reduce lending discrimination. 

However, these efforts to help more Americans become homeowners laid the groundwork for the financial crisis of the late 2000s. With pressure from the government and community organizations to issue more mortgages, a seemingly endless market expansion that appeared ideal for securities (but actually included inflated home valuations), and banks selling off mortgages to securities just days after issuing them, banks loosened qualification requirements and put less effort into verifying borrowers’ ability to repay loans. We all know what happened next.

Mortgages Will Continue to Evolve. What Does That Mean for the American Dream?

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These housing crises forced the government to adjust how mortgages are handled in the US, and this is sure to keep happening as America’s housing market evolves. Homeownership in the US has risen from about 48% before the Depression to around 68% today. However, as renting increasingly becomes the more affordable option in suburban and urban areas, this growth is tapering off, and 1 in 15 mortgaged homes are seriously underwater. 

What that means for the American mortgage industry is anyone’s guess. In many parts of the world, prospective homeowners buy land and build on it over time, expanding their home as finances allow without incurring any debt at all. In places like Singapore with some of the most expensive housing markets in the world, the vast majority of citizens own and live in government-built and subsidized apartment units.

At their core, modern home loans in the US are the result of a deep-held belief that single-family homeownership is a national ideal. This belief has motivated decisions from multiple federal administrations to support Americans in their pursuit of homeownership; decisions with sometimes catastrophic consequences down the line. It will be interesting to see the creative ways lenders continue to navigate this country’s unique mortgage market as challenges to that ideal arise.