Buying a new home is a big step, and often the largest financial decision many…
Right now, mortgages are an integral part of the economic landscape, and yet they really haven’t been around as long as many people think.
They were first introduced in the U.S. in the 1930s as way to make home ownership a possibility for the general public, and not just for the super-wealthy.
Previous to this time, lenders could set their own terms and make their own demands, most of which were far out of the reach of the average family.
So, let’s take a look at the history of the mortgage in this country. We’ll examine how they came to be, the ups and downs of the system over the years, and where it’s going in the future.
The Federal Housing Administration
Throughout the Great Depression, the government was desperate to get the economy rolling again, which led to the creation of the Federal Housing Administration (FHA) in 1934. The goal was to help increase home ownership – to create new home owners.
Because the purchase of a home has a significant impact on many other parts of the economy.
Homeowners will immediately spend money to maintain or improve the house. Now, they’re hiring contractors to make improvements, buying new furniture, and landscaping their yards.
This, in turn, means builders get more work and hire more people and retailers place larger orders to keep their inventory up. Then, this rippling effect continues throughout the rest of the economy.
The FHA stepped in to an industry that was almost completely under the lender’s purview. This led to rampant discrimination in the lending process, based on age, race, and many other characteristics the lender believed could impact the borrower’s ability to repay a loan. And most loans were already out of reach for the average family because down payments could run in the range of 50 to 80%.
At this point, we’re still not referring to these types of loans as “mortgages” yet. The FHA did not come in and declare that this is how “mortgages” would work. In fact, the “FHA loans” that were instituted were not loans at all.
They were (and are) insurance policies on loans.
All approvals are still handled by the bank or other financial institution, it’s just that they’re a little more willing to provide the loan because they were backed by a government agency. It may not have been the perfect solution, but there was at least a greater chance that they’d see at least a large portion of their money back if the borrower defaulted.
This, however, was dependent on whether or not the lender strictly followed the FHA’s specific lending guidelines. If they didn’t follow the rules, they wouldn’t qualify for the protections.
And these are the rules that started to lay some groundwork for how mortgage loans work today.
Buying and Selling Mortgages
Once the guidelines and definitions were in place for home mortgages, the next major evolution happened around 1938.
The Federal National Mortgage Association (FNMA), better known as Fannie Mae, was created to foster even more home ownership by creating a secondary market for these home loans.
Why would something like this make a difference?
Because financial institutions, like any other industry, have to remain liquid. They need to have ready access to resources that will let them grow.
So, now, mortgages became more than a financial transaction. They became a commodity that could be bought or sold.
This was an important evolution because if a bank loaned out all the money it had set aside for that purpose, they’d have no choice but to wait until the interest on those loans generated enough money to make more loans to other interested buyers.
Now, lenders can sell those mortgages to other lenders or financial institutions, helping them remain liquid, so they can continue to lend to others.
What Created the Housing Bubble?
We can’t talk about this kind of mortgage selling and buying without talking about the housing bubble.
In the mid-2000s, home ownership was hitting record highs. This was great because it looked like the entire housing market was on a continuous upward trend.
Lenders were still approving loans based on establish standards – for the most part – but slowly, it became apparently that the market essentially saturated. In other words, if homeownership is so high, who were they going to lend more money to?
So, to reach new buyers, some lenders began inventing new loan programs that would cater to people who probably wouldn’t qualify for a traditional mortgage. These were called subprime mortgage loans, and, as the name suggests, they were for people who “damaged” or “below prime” credit.
On top of that, while the introduction of the FHA had brought down payment requirements down to around 10% all those years ago, these loans re-established a program that required down payments of up to 40% to offset the risk.
These lenders also began to offer reduced-documentation or no-documentation loans. These aren’t anything new, but they were originally meant for self-employed borrowers who had great credit or some serous assets.
Offering them to people with poor credit really changed the marketplace.
Subprime and no-doc mortgages started to become commonplace, accounting for nearly two out of three loans issued at the time.
Very nearly anyone, whether they could document their assets or income or not, could get a home loan.
This probably seemed like a great idea to these lenders at the time. Homes were purchased, and then immediately sold again – often several times in a year.
People were getting loans just to buy and flip the house. And it was working.
For a while.
Eventually, though, the saturation point meant that there were simply no more buyers, and people purchasing homes for a quick flip found themselves sitting on homes they couldn’t afford.
This sent the market into a downward tailspin. Foreclosures ran rampant, and home values crashed hard. And since, as we pointed out above, the home market has a huge impact on almost every corner of the economy, the housing industry pulled a lot of others down with it.
Re-Establishing Reliable Guidelines
It took some time, but the mortgage industry has straightened back out. There is no such thing as a no-documentation loan anymore, and every single loan must establish the source of the borrowers’ down payment and closing costs and ensure that they can afford the monthly payment.
A lot of this was accomplished with a new organization that was created to enforce the rules. The Consumer Financial Protection Bureau (CFPB) sets mortgage rules that all lenders must follow if they want to continue to receive the protections that the FHA developed all those years ago.
Lenders still have some freedom to make a loan outside those rules, of course, but that loan cannot be sold to anyone else. In other words, the risk is theirs and theirs alone.
This has returned the mortgage industry to a situation much more reminiscent of the environment before the mid-2000s.
Where Does the Industry Go from Here?
There are fewer loan programs on the market, now, and the ones that are available are underwritten to a specific set of guidelines.
This means that there will be higher competition to attract borrowers. Mortgage loans in Seattle are going to face some stiff competition, because lenders want to work with you and help you get into a home that you can afford.
The lenders today are the people who survived the housing crisis. The ones that didn’t jump on the subprime bandwagon.