In the wake of the housing market collapse of a few years ago, lawmakers in Washington are debating the future of Fannie Mae, Freddie Mac, and government involvement in the housing market. One issue is the 30-year fixed-rate mortgage, a loan U.S. homebuyers take for granted, but is decidedly uncommon in other countries. In thinking about the role of the 30-year mortgage, it helps to know how it got started.
As late as the 1920's, someone taking out a mortgage to buy a house in the U.S. would most likelyl get a short-term balloon mortgage. Typical terms: 50 percent down, and five years to pay off the other 50 percent. At the end of the five years, it was common to re-finance into another five-year loan.
Then came the Great Depression. Many banks failed, and surviving banks didn't want to refinance these balloon mortgages. Banks foreclosed. Between 1931 and 1935, a quarter mllion people lost their homes each year.
President Franklin D. Roosevelt stepped in, explaining why the government shouldn't just sit by: "Even before I was inaugurated, I came to the conclusion that such a policy was too much to ask the American people to bear. It involved not only a further loss of homes, farms, savings and wages, but also a loss of spiritual values -- the loss of that sense of security for the present and the future so necessary to the peace and contentment of the individual and of his family."
To stabilize the economy, Roosevelt created federal agencies that form the basis of the housing market the United States has today. They provided mortgage insurance, established a secondary market for mortgage loans, and converted 1 million loans into long-term mortgages.
Professor Susan Wachter, from the Wharton School, says the changes were transformational. "It made housing affordable and it made housing, homeownership, sustainable."
More people could afford to buy, and keep, a home. Home costs were disconnected from the business cycle. Mortgages became safer.
"The loan will not come due until the loan is paid off," Wachter said, "and it will do that over the long term, which makes the loan affordable. When you stretch out the payments, they become affordable."
The maximum length of a mortgage was extended to 30 years in the 1940's, making home ownership even more affordable -- and stimulating the housing market. Today, Roosevelt's economic fix not only is still with us, it's the norm. In the first half of this year, the 30-year fixed-rate mortgage accounted for nearly 90 percent of new mortgages.
"It's a protected species," says Robert Bridges, a professor of economics at USC. "It stands out as a great thing if you can get it."
That is, great for the borrower. The 30-year fixed-rate mortgage, Bridges says, has all sorts of protections -- for one side.
"One-sidedness comes, No. 1, from locking in that interest rate over an outrageously long period of time," he says.
By locking in the rate, borrowers are protected if interest rates go up -- for 30 years. And, there's no refinance penalty, so they can refinance and lower their costs if interest rates go down.
"It doesn't make it an attractive investment for banks any longer," Bridges says, "and that's why we have the public so heavily involved in underwriting and backstopping domestic mortgagages."
If the government ever decides to get out of the business of backstopping mortgages, to privatize the mortgage market, some economists think the 30-year fixed-rate mortgage -- the mortgage Americans take for granted -- could become a whole lot more expensive, or even disappear. The long-term mortgage is a bet a lot of lenders don't want to take on their own.