Businessweek magazine celebrated their 85th anniversary by listing what they deem the 85 inventions with the greatest impact over the last 85 years. #1 was jet engines, but #17 was the fixed-rate mortgage.
At the time, it was bold and controversial decision done in response to the Great Depression. The government wanted a way to refinance home mortgages currently in default to prevent foreclosure:
In 1933, to provide stability, the now-extinct Home Owners’ Loan Corp. introduced a new type of mortgage: It had a fixed rate and was fully amortized, meaning borrowers paid off the entire loan by the end of the term. Not everyone cheered. Critics railed that it was “crazy and un-American [to be] putting people in debt for 15 years,” says Louis Hyman, author of Debtor Nation: The History of America in Red Ink.
That last quote suggests that a 15-year mortgage was really long and people used to pay off their mortgages a lot faster. I’m not really sure if that was the case, or if there was just a big split between people who could pay cash for a house and those that couldn’t. Wikipedia states that the previous standard in the 1920s was either 3-5 year interest-only mortgages offered by commercial banks or 10-12 year loans which required buying shares in the lender itself (not good when the share value plummets in an economic crisis).
If you think about it, fixed-rate mortgage are pretty reasonable terms. A fixed payment every month evenly spread out over 30 years, and as long as you don’t miss any payments you’ll be fully paid off by the end of the loan period. It kind of makes you wonder if private companies would have created such an instrument in the “free market” absent government intervention. Of course, you have to wonder what would housing prices be like without their existence? (Just today I see that Fannie and Freddie announced the backing of 3% downpayment mortgages.)
Since they do exist, I still think people should use them to time their mortgage payoff with their retirement date. For many people, a 30-year fixed rate mortgage will do just that if they don’t refinance into a longer term. Start at age 30-something, finish at 60-something. For those that are serious about early retirement, then the 15-year mortgage may be a better fit.
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I’ve read numerous things over the years that suggested prior to the 30-year mortgage the commonplace thing was 5-year interest only mortgages. At the end everyone had to role over to a new 5-year interest only mortgages. If you were lucky you were able t scratch together enough to pay additional principle payments along the way. The big problem was given that people were applying for mortgages more frequently (every 5 years) trying to get one (even a roll-over to a new one) was more difficult as timing-wise it would be more likely to coincide with a financial panic / bank contraction, etc. So in turn real estate prices used to fluctuate more back in the 19th century, because there would be huge numbers of people unable to get new mortgages at the same time, and then all be forced out of there homes / farms concurrently driving prices down. At least that is what I teased out of the history books and remember, but could be widely inaccurate.
What I’ve always thought was a bit odd about the 30-year fixed rate mortgage is that you always see constant periodic payments. But even small 2% average inflation comes into play over 30 years. Also people progress in their careers over 30 years and often earn more later even despite inflation. So why not have a 30-year fixed rate mortgage but with non-constant periodic payments to better suit that reality. For example, a required minimum mortgage payment that (to pay-off on schedule in 30 years) starts off lower, but rises like 1 or 1.5% per year. So the monthly payments in the final year would be like 35-55% more per month than in the first year. In comparison to the traditional 30-year this would mean a larger percentage of the total monthly payment in the early years would go towards interest (which you’d think the banks would like), and also better match the reality of peoples ability to pay more as they age (which you’d think the buyer would like). So over all the principle pay-off curve starts and ends at the same places, but drops more slowly than the standard curve in the early years, and then drops steeper than the standard curve in the final years. This would of course actually be worse, more costly, for people selling a house before the end of the 30-year mortgage, but I claim it better fits the consumer if they stay in the home for 30 years. (National average is like 5-8 years, right?) Sure, as a mortgage holder you can mimic this by raising your payments over time, but if you’re using a traditional 30-year mortgage that will mean paying off before 30 years. I’m describing still having a 30-year time horizon, so I guess if you could get a 40-year mortgage, and then you could increase the payments yourself to create a 30-year pay-off on that 40-year mortgage.
There is a product that accomplishes what you describe: an interest only loan, and you have the flexibility to pay whatever portion of the principle you want each month–increasing it when you get raises etc.
The issue is, banks don’t want to make these loans for very long as they bear the inflation risk, which gets really big over the long term, so you end up having to roll over every 5-7 years or so, and who knows what inflation/rates will be then.
Sure, an interest-only loan is at the far other end of the spectrum. I’m basically describing a blend, but much closer to the 30-year fixed side of the spectrum. This way buyers get to lock-in the long term fixed rate, and have a loan structured to better fit their expected changing situation in the future. And the bank gets more interest (profit) in the early years, and actually doesn’t face anywhere near as much inflation risk as you mention with a interest-only loan. This blend has always made sense to me, and I’ve been surprised I’ve never seen it out there in the real world.
With an interest only loan the bank bears the interest rate risk of the entire principle over the whole duration. If the loan is setup like a standard fixed rate loan the principle goes down, and thus less risk as time goes on.
The real reason the fixed is so mainstream though is because banks can unload them immediately to fanny may/mac and not take on any increased risk.
If you look at an amortization schedule, you are already paying a large % towards interest and very little principal in the first years of a 30-year mortgage. To reduce the payment in the early years and offset that by higher payments later you would likely need to put the loan into a negative amortization (i.e. paying less than the total interest in the early years and therefore adding to the principal balance each month). That would be pretty controversial in today’s political/economic climate given where we’ve been with sub-prime and exotic mortgage products and the housing crisis. Basically the skeptics would just see this is a way for people to buy more house than they can afford.
Canadians still await this invention…
It’s interesting that the 30-year fixed mortgage is basically an American thing. I don’t think it is widely available in any other part of the world. That says something about it’s existence if not backed by the government.
I’m curious as to the effects of increased capital availability has on prices. By having a longer structured loan are higher market prices for homes supported? It certainly encourages the “buy what your future self can afford” mentality I hear from realtors.
I had to chuckle at this: “crazy and un-American [to be] putting people in debt for 15 years,” What a different time. My grandma talked about how they paid $1k for their home (granted it was in rural town America). But, amazing to see how the prices have skyrocketed and homes are often 5-7x folks’ annual salaries. I think extending the mortgage out for so many years has resulted in long-term indebtedness. It is the “norm”.
I couldn’t imagine the risk of a non-fixed rate mortgage. Even a small increase could drastically change your monthly payment obligation. Adjustable rate mortgages are still available, but when the fixed rates are so low there really is no point in going that direction.