When speaking in terms of chasing and achieving the proverbial American Dream, home ownership is the economic activity that most people associate with financial freedom. This is a tenet that goes back to the days of the American Frontier, and it still holds true despite the effects of the housing bubble in the United States. Over the last few decades, millions of Americans came closer to making their version of the American Dream a reality thanks to a lending product which made the cost of acquiring a home truly affordable: the 30 year mortgage.
The New Deal
The 30 year mortgage originated as a result of President Franklin Delano Roosevelt’s wide-reaching initiative to restore American economic confidence after the Great Depression. Part of the New Deal consisted in making home ownership affordable to Americans through the process of fair lending. Prior to the New Deal, mortgage lending was essentially a free-for-all exercise in usury. Home loans were typically of the short term variety, between 3 to 5 years, they did not amortize and often included a balloon feature. This meant that a borrower could owe a large amount of money to be paid in lump sum to the bank at the end of the mortgage term. Borrowers were not protected by any means, as the bank could “call the loan” (demand payment in full) at anytime during the life of the loan. Interest rates were set arbitrarily by the bankers whose sole focus was to extort payments and look for ways to foreclose the loan.
In the 1930s the banking system eventually collapsed, sending ripples of financial damage throughout the economic system. When Americans began losing their jobs in record numbers and were no longer able to make payments on their mortgages, the banks moved quickly to foreclose on the properties of delinquent borrowers. The banks would soon regret their greed as the housing market would also collapse and left them holding on to real estate portfolios of no value. With unemployed Americans losing their homes in record numbers, people looked to the Roosevelt administration and the New Deal to help them restore confidence in the mortgage lending system,
The FHA Loan
The Federal Housing Administration (FHA) was created with the following goal in mind: to regulate the rates and terms of mortgages and to insure home loans. The creation of fair lending practices by the FHA led to an increase in the number of qualified borrowers: people who could not only afford the down payment on a home, but who also had a reasonable ability to repay the mortgage over the life of the loan. The FHA recognized that the market for single-family homes was dynamic and subject to adjustments due to economic conditions; thus the FHA created a set of guidelines for refinancing mortgages.
The FHA saw a clear need for a lending product which allowed borrowers to make affordable payments on their mortgage while they worked and earned their way to retirement. Thirty years were seen as a reasonable term to assume that a borrower would be in the workforce before they retired. By that time, a borrower would have ideally paid off the mortgage and would enjoy a property which was free and clear of any liens.
Armed with these new guidelines established by the FHA, hundreds of thousands of American men and women returning from military service during World War II were able to afford a new home for their families. This in turn led to a shift in the American economic landscape as more and more people became homeowners. Roosevelt’s New Deal had worked effectively on that level, and a bright future loomed for the housing market in the United States.
The Modern 30 Year Mortgage
In today’s residential lending marketplace, the 30 year loan is often referred to as “traditional”, “conventional”, and “conforming”. Usage of these terms may lead some people to believe that 30 year mortgages are old fashioned lending products, when in fact they are anything but. Since their creation by the FHA, 30 year mortgages have become a benchmark of the US economy. Whenever the national average mortgage rates are reported by the financial news media, they are invariably referring to 30 year mortgage rates which are tied to the yield of the 10 year US Treasury Bill (the “T-Bill”).
The interest rates of 30 year mortgages are conventionally set by the daily yield of the T-Bill, which in turn is used as a barometer to gauge the state of the overall national economy. Consider, for example, the exorbitant 30 year mortgages during the early days of the Ronald Reagan administration: an 18% interest rate was not so uncommon back then. Since the rates are intrinsically tied to the overall health of the economy, it’s easy to understand that after the terrorist attacks of September 11 the 30 year mortgage rates took a plunge and paved the way for a vibrant real estate market which would eventually result in the housing bubble. And during the darkest days of the economic crisis of the mid 2000’s, 30 year mortgage rates were even lower than they had been post 9/11.
It is important to note that unlike other types of mortgages (such as the infamous “option ARM” which is believed to have been a major contributor of the mortgage lending meltdown of the mid 2000s), the great majority of 30 year mortgages have a fixed rate throughout the life of the loan. Modern 30 year mortgages also have many other beneficial features such as full amortization, maturity, and US government-backed insurance to the lender. Understanding these modern features is essential for new borrowers.
Features of the 30 Year Mortgage
Fixed Payment
Besides the fixed rate of interest, a 30 year mortgage includes other important features. Unlike some other interest-only lending product, most 30 year mortgages have a fixed payment which is fully amortized. This means that even though over the life of the loan the payments made to the principal will increase while payments made on interest will decrease, the monthly payment amount required to be paid by the borrower is not subject to change.
Points
Just like with any other loan, a borrower will likely be subject to paying points on a mortgage at closing time. Points are calculated when all the fees associated with originating, processing, closing, and funding the loan are added up. Fair lending practices dictate that all points and fees be disclosed to the borrower upfront. In some cases, points may be financed or “rolled into the loan” if the borrower does not have sufficient funds at the closing table; although this may considerably increase the total amount of interest that must be repaid.
Down Payment
In order to keep 30 year mortgages affordable and insurable, many borrowers will be subject to a down payment when purchasing a new home. While the required amount will vary from one lender to another, all borrowers must realize that a down payment of at least 10% of the purchase price of the property is recommended in order to build equity in their home as quickly as possible. This is very important when shopping for a mortgage loan since the rate of interest tends to be directly proportional to the down payment provided.
Insurance
Another feature commonly seen nowadays in 30 year mortgages is mortgage insurance. This is a premium amount that is paid by the borrower and it serves to protect the lender in case of default. Along with government-backed guarantees, mortgage insurance is a feature that allows borrowers to purchase a new home that is priced at several times the amount of their savings or income. Without mortgage insurance, lenders would not be willing to issue mortgages to borrowers who don’t make at least a 20% down payment.
Overall Benefits
Detractors of the 30 year mortgage sometimes point at their lack of “flexibility”. This is often not the case, as 30 year mortgage note and contracts are clear, concise, and usually allow a borrower to refinance easily. There is a reason why the Federal Housing Administration nowadays guarantees 30 year mortgages more than any other home lending product: they are safe and sensible financial instruments that can be renegotiated without worries.
Savvy borrowers tend to favor these loans due to their low rate and lack of surprises. The fixed low payments of 30 year mortgages are very adequate in times of economic instability. Smart borrowers seeking to build up equity and financial security at a safe and measured pace are good candidates for a 30 year mortgage.