Mortgage – a tool that made the American dream of becoming a homeowner a reality! Did you know borrowing money to buy a home wasn't common practice until a few decades ago? Interested in learning more about mortgages and how they evolved into what it is today? Let's dive in!
Evolution of Mortgage
Before we tell the tale of mortgages, let's first understand where the term came from and what it means? In Latin, "mort" means death, and "gage" means pledge. So basically, a mortgage is a death pledge. In simpler words, it's the end of a pledge once a loan is paid off. Not as bad as it sounds, right?
The concept of a mortgage for a home wasn't invented until the 1930s. At the time, less than 40% of American families owned homes, and those who didn't have the funds to buy a home outright were pretty much out of luck. Thankfully, that situation was about to change soon with the advent of mortgages in the early 1930s.
In the beginning, a mortgage was quite a private affair with no federal insurance or regulations. Mortgages had a typical down payment of 50% and a short repayment period of about 5 to 10 years. At the end of which, the entire principal amount was due in the form of a large, one-time balloon payment, making it’s an unviable option for most families.
The Great Depression
Along came the era of the Great Depression, which damaged the entire financial institution, more so the mortgage sector. During which the mortgage delinquency rated surged to a whopping 50% as most mortgage lenders failed.
The Depression caused the housing prices to drop by 25%, and the homeowners could no longer afford their balloon payments. As the banks didn't allow refinancing, about 1000 homes were in foreclosure every day in 1933.
The New Deal
Needless to say, the real estate and the mortgage market was in a dire strait post-Depression. Then-President Franklin D. Roosevelt responded by creating a host of regulations and institutions. He proposed five critical housing-related changes:
The Homeowner's Loan Corporation bought 1 million defaulted mortgages and reinstated them as 15-year and 30-year fixed-rate mortgages.
Introduced mortgage insurance through federal housing administration
Created a secondary mortgage market through government-sponsored enterprises, today known as the Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation)
Insured bank deposits through the Federal Deposit Insurance Corporation
Prohibited banks from investing depositors' funds in risky ventures like the stock market by implementing the Glass-Steagall Act
These changes attributed homeownership to what we know today, making it more affordable and long-term, thereby reducing the monthly payments. Following this transformation, the American homeownership rate soared from 44% to 62% between 1940 and 1960. The newly formed Federal Housing Administration and Veterans Administration empowered more Americans to become homeowners.
The year 1938 – Enter Fannie Mae
The Federal National Mortgage Association, nicknamed Fannie Mae, was created to increase the amount of money available to borrowers by purchasing FHA-insured loans and selling those loans as securities on the financial markets. This created a secondary mortgage market and a new source of capital for lenders. In addition, Fannie Mae mandated fair and efficient lending practices and created capital in a starved economy.
The 1940s and 1950s
Veterans Administration was created to assist veterans returning home post World War II to purchase homes at affordable rates without a down payment. Veterans Administration protected private lenders against borrower default by insuring mortgage loans. This was a popular system that created a massive demand in the housing and mortgage market, further boosting America's economy.
The 1970s – Enter Freddie Mac
With time the housing demands of Americans expanded, which required larger loans. However, the mortgage market didn't have enough capital to finance homebuyers' growing needs. That's when the US Congress created the Federal Home Loan Mortgage Corporation nicknamed Freddie Mac to increase the capital available to lenders and, by extension, to borrowers.
Freddie Mae offered 30-year fixed-rate mortgages at a lower interest rate to protect borrowers against rising interest rates in the future. Meanwhile, the interest rates continued to rise sharply through the 1970s and 1980s, eventually rising above 20%! It was decades later, in the 1990s when the interest rates fell below 7%.
The 1980s – Adjustable Rate Mortgage
Adjustable-rate mortgages were introduced in the 1980s, which allowed borrowers to reap the benefits of lower interest rates throughout their loan repayment period. This was especially beneficial when the interest rates dropped from 20% to under 5% a decade later.
The 1990s
The high interest rate of 20% discouraged Americans from buying homes, so the government encouraged sub-prime lending to boost the homeownership rate to 70%. During this, the sub-prime mortgages expanded from $35 Billion to $125 Billion, making millions of unqualified candidates, homeowners.
Financial Safety and Soundness Act of 1992
In 1992 the Federal Housing Enterprises Financial Safety and Soundness Act (FHEFSSA) was passed to enhance government oversight of the mortgage industry. The FHEFSSA created the Office of Federal Housing Enterprise Oversight for Fannie Mae and Freddie Mac and established minimum capital standards for both companies. However, those capital standards turned out to be too low, causing taxpayers to bail out both government-funded companies during the Great Recession.
The Great Recession
The mortgage companies had a great run up until the Great Recession of 2008. Several factors were responsible for the Recession, including the US housing bubble peak of 2006, subprime lending, and the lack of liquidity. The housing bubble finally exploded in 2008, causing record-breaking price drops coupled with subprime lending fueled by a lack of regulation.
Mortgage Scenario Today
The American mortgage market is the largest, most innovative, and equally intricate home financing system available today. The future of the mortgage depends in part on the private-label mortgage-backed securities and any potential federal government interventions in the housing and borrowing market.
Types of Mortgages Available Today:
Fixed-Rate Mortgage
Adjustable-Rate Mortgage
Reverse Mortgage
FHA Loan
Interest-Only Loan
Balloon Loan
No Money Down Loan
Exotic Sub-Prime Loan