Arnold Kling  

More on the 30-year Fixed Rate Mortgage

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Mark Perry writes,


It wouldn't take much of an increase in inflation and short-term interest rates before many banks/thrifts could see their interest margins squeezed, and short-term rates could conceivably even rise above 5% sometime in the next 30 years, which could put the banks "upside down" again and lead to failures.

Mark, like me, remembers the way the 30-year killed off the thrift industry. Today, though, banks and thrifts are not the ones holding mortgages. The main holders now are Freddie, Fannie, and the Fed. This means that when interest rates rise, the taxpayers will lose automatically, without even having to bail out banks or thrifts.

When I gave my rant last week, it was Michael Lea, an economist in the audience, who said that no other country uses 30-year fixed-rate mortgages. That view has been disputed in various comments. Fine. But I would still bet that the vast majority of other countries rely on something other than 30-year fixed-rate loans for the majority of their mortgages. And I am 100 percent sure that there is lots of foreign experience that proves that you can have a viable housing market with little or no use of the thirty-year fixed-rate mortgage. And that is the main point--that there are plenty of examples demonstrating that we could get along without that mortgage.

My guess is that it would take a while for Americans to become comfortable with different mortgages. But if the government were not subsidizing the 30-year with a prepayment option, my guess is that eventually the market would converge on something else.


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COMMENTS (11 to date)
Rebecca Burlingame writes:

Shorter mortgages are better. Even so, I discovered that a fifteen year note was bundled and no longer in the bank when selling a house, before the housing crisis. Would shorter notes continue to be bundled and sold as before?

Richard A. writes:

"It wouldn't take much of an increase in inflation and short-term interest rates before many banks/thrifts could see their interest margins squeezed"

Just maybe the primary objective of the Fed for the past couple of years is to keep inflation and short-term interest rates low at the expense of the economy.

IOW, maybe the Fed has deliberately kept the growth rate of nominal GDP low to keep short-term interests rates low.

geckonomist writes:

30 years fixed rate mortgages are popping up all over Europe in places/cities where house prices have risen a lot in the last decade.

tom writes:

1. Is your worry that the risks of lending on 30-year low-fixed-interest terms are unhedged by our government and private holders, or that they are unhedgeable?

And what's the result if we move to 15-year products over the next few years, with either non-teaser fixed rates for some period or simple floating rates? Would that effectively stop new housing for a couple of years? Would many new homes be apartments instead of single-family units? Are you really saying that we need to shrink houses?

2. If our biggest expenses are housing, education, and old people health care, and if costs and/or risks of each have been taken on by the government whether through government guarantees, government issued loans, special legal status and/or tax treatment(home mortgage deduction, no discharge of education loans), or government payments, then how much have these subsidies warped Americans' consumption over the past 30 years (just since 1980, with Reagan)?

And how can we even imagine the neigborhoods we would live in, the cities that would not have boomed, the kids who would not have spent four years in third-tier liberal arts colleges, the aunts who wouldn't have government-paid Rascals to scoot around in?

Even going back just a few years, imagine if there had been some scandal at Fannie and Countrywide in 2003 that had served to inoculate us against the bigger problems to come.

Pierre writes:

As a Canadian I'd never even heard of a 30 year fixed rate mortgage until I started paying attention to the financial crisis. I have the - fairly typical in Canada - 5 year fixed rate mortgage with the payments determined on a 25 year amortization. Oh, sorry, currently I have a 4 year fixed rate because of a rate sale at the bank when I bought my place.

Anyhow, the Canadian housing market is doing quite well, and the local market has been hot since at least 2003. I can't say that that will continue; likely not.

Pierre

Washington Hogwallop writes:

There are very few banks (in number) who portfolio mortgages any more, but from what I understand many of the TBTF banks still do.

Does anyone have insight into how they hedge this interest rate risk (along with FHLMC and FNMA)? If at all I suppose.

Dan King writes:

How exactly is a 30 year fixed mortgage different from a 30 year treasury bond?

OK, lots of ways, but they both pay a fixed rate of interest for 30 years, right? And one is an evil bank killer and the other is ok? Huh?

[Comment edited for crude language.--Econlib Ed.]

Van Veraf writes:

I'm not that experienced, but in South Africa where I was into doing bonds for a year, variable rate residential mortgages are the norm. In rare cases clients applied for an up to five years fixed interest rate (which could be acquired at a premium).

I was really struck by it when I first heard of how common 30 year fixed rates are in the US.

Ella writes:

Part of the popularity of 30-fixed is because housing is grossly overpriced relative to income. Housing would have to drop by another 50% or more to bring asset prices close enough to incomes to be able to pay off a home in 5 to 15 years, and to allow people to save enough money to get a large enough down payment to be able to get a short-term loan.

Alex writes:

I'm always curious to see where these rates go. I'm not that close to buying a house yet (just out of college) but I hope something changes in the future for mortgages to be more stable. I've always been looking around at rates for different kinds of mortgages like Nationwide Bank's loan rates or something like Bankrate. I'll continue to keep looking at these rates the closer and closer I get to purchasing a house; I'm crossing my fingers it doesn't become too difficult to sustain a mortgage.

xyz70 writes:

Actually, we could assume that the bank lends at floating and then allows the borrower to swap into fixed. The prepayment option is a call. The borrower is long a call on his mortgage and he's long a put on his house (in the event of default followed by foreclosure). I assume that all of these are priced in or could be priced in. It would seem, however, that mortgage lenders and investors neglected to hedge their exposure to their short position in house puts.

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