How the U.S. mortgage system came to be
When Geoff and I bought our condo in the summer of 2020, it felt like we took a crash course in housing finance. To be quite honest, I didn’t understand half of what our mortgage broker was saying to us. She always spoke really fast lol. And then almost immediately after our sale closed, the mortgage was sold to Freddie Mac. We didn’t have to do anything differently, but still, I couldn’t shake the feeling that a lot of different people made a lot of money when we closed on that loan (they did!).
This is incredibly common. Lenders will sell mortgages to companies like Freddie Mac and Fannie Mae, publicly traded companies that were chartered by Congress in 1970 and 1938, respectively, with the goal of “keeping money flowing” in the mortgage industry. The idea is that when a lender sells a mortgage on the secondary market, the lender sheds the loan’s risk and replenishes its funds, thus freeing them up to make more loans. They make money in a few ways, including by charging borrowers origination and other fees.
Why does this system exist?
I’m so glad you asked. There was once a time when a single-income household could reasonably save up to buy a house without needing a big loan, but mortgages have been around in some shape or form since the 1700s. We’re going to jump ahead to the 1920s, though. Let’s say you’re looking to buy a house. You’d head to a mortgage bank or a savings and loan company, and if you were successful, you’d walk away with a 3-5-year loan for about 50% of the value of the home you had your eye on. You’d pay interest in a few years, and then you’d owe a big lump sum – a balloon payment.
The 1920s also saw a rapid increase in home values. Using Manhattan as an example, prices “reached their highest level in the third quarter of 1929 before falling by 67% at the end of 1932 and hovering around that value for most of the Great Depression” (Nicholas & Scherbina, 2013).
Enter: The Homeowners Loan Corporation
aka HOLC, aka the agency largely credited as the maker of the redlining maps*. Foreclosures were up and the market was in free fall, and FDR created this temporary agency in 1933 to help Americans avoid foreclosure during the Great Depression. HOLC’s work was financed by government-guaranteed bonds. HOLC did not actually issue new mortgages, but refinanced existing ones, transforming them into “20-year, loans with monthly payments of interest and principal at fixed rates of interest” (Forbes).
Here comes the FHA (boo, hiss)
I could geek out about New Deal-era America forever. So many incredible, progressive policies were born during that period but as you know (I hope), those benefits were not equitably distributed and the FHA actively discriminated against Black Americans and anyone who wanted to purchase a home in a neighborhood where Black people lived.
However, the FHA helped shepherd the long-term, government-backed mortgage beyond HOLC’s initial mandate, which made homebuying more possible for more (white) Americans. They also insured mortgages at up to 80% of the property’s value, which was a dramatic increase from the 50% more common pre-Depression. This is where we get to that whole 20% down rule-of-thumb.
Banks didn’t really jump at the opportunity to buy these FHA-insured mortgages though, so Congress created Fannie Mae in 1938 to help provide a market for them, and later, for VA loans.
(*FUN FACT though: HOLC’s maps actually probably didn’t impact the Federal Housing Administration’s racist lending practices. HOLC worked with existing home loans, whereas the FHA explicitly discriminated against Black would-be homebuyers as they sought to create “financially secure” home loans. This was the beginning of America’s sick love affair with super white suburbs.)
(OTHER FUN FACT: The FHA’s maps were mostly destroyed in 1969 by the Nixon Administration in response to civil rights litigation. I just picture Nixon as this really pissed-off, paranoid guy who created a culture of fear and control. Sort of hilarious but also has really frustrating implications for housing discrimination research.)
Jumping ahead to 2007 + Lots of simplification
Strangely, a lot of financial institutions started lending in similar ways to post-Depression institutions – adjustable-rate mortgages, interest-only mortgages, etc. (Forbes). They also started lending sub-prime mortgages. This whole “let capitalism do its thing” idea never really works, but okay, sure.
There were a number of other factors at play during the 2008 housing crash, like investors buying mortgage-backed securities that had actually become really risky thanks to those more sketch lending practices, but that’s sort of beyond the scope for today.
Even when adjusting for inflation, homes are significantly more expensive now than they were in the early 20th century thanks to a sharp increase in land prices, demand (the estimated U.S. population in 1930 was about 123.2k… right now it’s 329.5 million), and building costs.
Most people need mortgages in order to afford homeownership. But the existing system is complicated financially, and may artificially deflate the true cost of buying a home in a high climate-risk area.
Housing finance is one of those things I want to learn a lot more about. My coursework probably won’t touch on it a whole lot until I take a housing policy course (either this Spring or Spring 2024), but I’m sure I’ll spend lots of leisure time reading about it lol.
