After more than 40 years of subsidizing and boosting homeownership, the federal government is talking about backing away. The Obama administration wants to eliminate federal guarantees for home loans for all but creditworthy buyers "with modest incomes" who otherwise could not get a mortgage from a private lender, according to a report that the administration gave to Congress in February (PDF).
Change like that could make buying a mortgage more expensive. Americans' favorite home loan, the 30-year, fixed-rate mortgage, would lose ground against other mortgage types.
There's even talk that the popular 30-year loan could become extinct, though that's unlikely.
"There would definitely be fewer 30-year mortgages, but they would not disappear," says Dean Baker, co-director of the Center for Economic and Policy Research in Washington, D.C. He wrote the books "Taking Economics Seriously" and "False Profits: Recovering from the Bubble Economy."
It's all talk, at this point, about how to shrink, change or eliminate Fannie Mae and Freddie Mac, the two huge, government-run corporations that have kept costs low for middle-class homeowners by guaranteeing home loans.
Massive defaults by homeowners, along with management and accounting scandals at Fannie and Freddie, are costing taxpayers hundreds of billions of dollars. Even political rivals agree it's time for a new approach.
The debate among regulators, economists, politicians, consumer advocates and lobbyists could continue for years before Congress passes a plan, experts say. After that, any changes would be phased in slowly over many more years.
Meanwhile, homeowners may wonder how this change could affect mortgages today and in the long term.
What's happening to 30-year mortgages?
Today, 80% of all mortgages are 30-year, fixed-rate, "conventional" loans, Freddie Mac says. "Conventional" means Fannie and Freddie can guarantee them, as long as they're below a maximum amount, so they're cheaper. By spreading lower payments over decades, conventional loans more expensive in the long run, but they've allowed many people to buy a home.
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At the tail end of the housing boom in 2008, the conventional loan's market share dropped as low as 67%. But at least 80% to 90% of all mortgages since 1990 have been conventional, Freddie Mac says.
But if the government eliminates the guarantee for conventional mortgages, buyers might look at other loan types.
"Without the guarantee, I think long-term, fixed-rate mortgages will still exist, but they'll be higher priced, and there'd be less of them," says Michael Lea, director of The Corky McMillin Center for Real Estate at San Diego State University. "You wouldn't see 90%, but you'd see maybe 30%."
Mortgages haven't always been cheap and easy. Look at the 1920s.
"It was a prosperous period, but if you wanted a mortgage loan, you put 40% down and got an interest-only loan for 10 years. And then you refinanced it," says mortgage expert Jack Guttentag, author of "Mortgage Encyclopedia: An Authoritative Guide to Mortgage Programs, Practices, Prices and Pitfalls" and of the Mortgage Professor educational website for consumers.
In most other countries — where governments don't subsidize mortgages or where they do it differently than we do here — the 30-year mortgage is a rare bird. In Denmark, the exception, it comprises about half of all home loans.
"You don't need 30-year mortgages to have high rates of homeownership," Baker says. In the U.S., homeownership is 66.5%, down from a high of 69.2% in 2004, the Census Bureau says. But other countries do as well or better with different financing systems and different loan types, and many suffered less during the housing crash.
Lea cites these 2008 homeownership rates, for example:
- Ireland: 74.5%
- Australia and the United Kingdom: 70%
- Canada: 68.4%
- Japan: 61%
Emerging markets often have even higher rates of homeownership because they don't have well-developed rental markets, Lea says.
Mortgages around the world
Lea studies mortgages globally; for more, read his report "Alternative Forms of Mortgage Finance: What Can We Learn from Other Countries?" (PDF). In the U.S., he says, the most-common mortgages are:
- Long-term, fixed-rate mortgages: These comprise about 90% of all mortgages, Lea says. Some are 15-year loans, and most are 30-year mortgages.
- Hybrid adjustable-rate mortgages: These ARMs are roughly 5% to 8% of all loans. They have initial fixed-rate periods, followed by adjustable rates that reset regularly, usually annually. The most popular are 5/1 ARMs — 5/1 means five years at a fixed rate followed by yearly interest-rate adjustments — then 3/1, 7/1 and 10/1 ARMs.
- Short-term ARMs: Roughly 1% to 2% of the market, these ARMs have no fixed-rate period and have one- to five-year terms.
But if conditions change, our mix could change. For a few examples, look at these countries:
Canada, Germany and the Netherlands: In these countries, rollover mortgages are popular. A rollover loan essentially requires the borrower to renew the mortgage at market interest rates at regular intervals, such as every five or 10 years. You can also refinance using another lender, but prepayment penalties are the rule, at least during the fixed-rate period. Throughout Europe, adjustable-rate loans are popular because their interest rates are considerably lower than fixed-rate loans. Also, hybrid mortgages play a larger role.
Many Dutch mortgages also are interest-only, which means you only pay interest for the life of the loan, which leaves the balance unchanged and ownership in the lender's hands. If never actually gaining an ownership share of your home sounds crazy, consider that these products are popular because tax benefits encourage them.
Spain: Spanish mortgages often are part fixed-rate and part variable-rate. You can take out two notes secured by one property. Unlike our first and second mortgages, these are two pieces of a first mortgage. One is at an adjustable rate and one a fixed rate.
Japan: About half of Japanese mortgages are "convertible": After a fixed period, the borrower chooses between an adjustable interest rate and another fixed-rate period.
Most of these loan products are available in the U.S., says Mark A. Calabria, director of financial-regulation studies at the Cato Institute.
"We think about the 30-year fixed, but there are a tremendous number of options," he says.
You don't hear much about these loan options because they can't compete in cost with government-subsidized, long-term, fixed-rate mortgages. But if those disappeared, borrowers who need low monthly payments might find the prices on five- or 10-year loans with adjustable interest rates more appealing. Today's borrower also is more mobile and more financially astute than in the Great Depression, when the government started supporting the home-loan market to help consumers, Calabria says.
"The typical amount of time people stay in a house is about 10 years," Calabria says. "The typical life of a mortgage is five years. The question is, do rates have to be fixed for 30 years when the average person keeps the loan only an average of five (years)? That makes no sense in this day and age."
Hybrid ARMs got a bad name because they were coupled with some of the worst abuses and risky products that subprime lenders pushed in the real-estate bubble. But no one's predicting a return — at least any time soon — of fraud-prone features such as exploding interest rates and loans requiring no documents, no down payments and no proof of a borrower's assets.
Prices going up
Meanwhile, Americans who still want the low-payment, predictable, 30-year-fixed mortgage undoubtedly could get it even if government support dissolves. It'll just cost more.
How much more? No one knows for sure. In Christian Science Monitor report, Bill Gross, a bond-fund investor who co-founded PIMCO and is a critic of the Obama plan, says that without government guarantees, homebuyers could pay 3 percentage points more on interest rates. That means a 4.9% rate today would be 7.9%.
Others point to jumbo loans — mortgages larger than the government will guarantee — which, because of higher interest rates, are more expensive than conventional loans but by far less than 3%. It's not a perfect comparison because jumbo customers are typically wealthier and pay a smaller premium for risk than a middle-class homeowner might. But Baker says the example could comfort some buyers.
"We have long had jumbo mortgages, with typically just a spread of 25 (to) 30 basis points with conformable mortgages," says Baker, who also says he thinks rates would increase by 30 to 40 basis points if conventional mortgages disappear.
A basis point is 0.01 of 1%. Twenty basis points would raise a 5% rate to 5.2%, increasing your monthly payment on a $200,000 mortgage from about $1,073 to $1,098.
Calabria says he thinks rates could rise between 20 basis points and a full percentage point if government pulled out.
Adding a full percentage point to your mortgage cost would raise the interest rate to 6%, making the monthly payment nearly $1,200.
Not everyone expects substantial change, however.
"I don't think we're going to see new kinds of products," Guttentag says. "There's nothing abroad in the form of mortgage products that is novel or attractive to us now.
"What's going to happen is an extension of what's already happened: Down-payment requirements are up, credit restrictions are up, appraisal requirements are tougher (and) documentation requirements have increased enormously."
If federal support for middle-class mortgages dissolves, Guttentag says he expects two or more tiers of mortgages to emerge. Cautious lenders may charge borrowers more for the degree of risk their credit profiles suggest, so you'd see a wider range of prices for borrowers.
Regardless of what policy-makers decide to do with Fannie and Freddie, expect no radical changes in the near future.
For the next three to five years, getting a mortgage will be much like today, experts say. The 30-year, fixed-rate mortgage will continue as the nation's favored home loan. Lenders will keep demanding down payments of 20% or more, plus lots of documents and details about every aspect of your financial life.
"Now the general philosophy and fear in the market is that we're going to get more declines in home prices," Guttentag says, "and the only way to protect yourself is to require more (for) down payments and higher FICO scores."
Borrowers and loans that don't fit lenders' standards will face rejection. Home-equity loans and mortgages for second homes and investment homes will continue to be scarce.
"This has particularly hurt self-employed borrowers," Guttentag says. "I get messages from people with 30% down, FICO scores of 800 and income well in excess of guidelines who can't get a loan because their income can't be adequately documented."
The one big difference is that costs will keep growing in the next few years. Lenders will pass along higher fees from Fannie and Freddie, called "loan-level price adjustments," based on your credit score and loan-to-value ratio. Interest rates are going up — by a percentage point or more, Calabria says —and are unlikely to drop. Many experts also expect inflation to pick up.
Any withdrawal of government support for middle-class mortgages, however, remains years away. But the chance is real that change could come to the American mortgage market.