Archives for December 9, 2014

The Invention of the Fixed Rate Mortgage

homefrontBusinessweek 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.