What's So Special about the 30-Year Mortgage?

One remarkable feature of the current debate in Washington about the future of Fannie Mae and Freddie Mac is the prominence given to one kind of mortgage--the 30-year, fixed-rate loan. The proponents of a continuing role for government in housing finance are going from office to office on Capitol Hill arguing that, without government backing, American homeowners will not have access to this particular loan. Many legislators believe that the 30-year, fixed-rate mortgage is good for homeowners and good for the government to support as a matter of policy.

There are two questions to ask. Is it true that this loan will only be made to homeowners if the government stands behind it? And is government support for this particular kind of loan good policy?

The idea that government backing is required for a 30-year, fixed-rate loan has some surface plausibility. Many people who don't follow the financial markets might assume that lending money for that long a period at a fixed rate would be too risky for the private sector.

it seems to have been a deliberate policy of the Department of Housing and Urban Development to reduce mortgage standards and down payments in order to assure that mortgage credit was available to a wider section of the U.S population

Anyone can prove this assumption is wrong, however, simply by going to Google and typing in "30-year jumbo fixed rate mortgage." The word "jumbo" is mortgage market jargon for loans that are too large to be bought by Fannie or Freddie, or insured by the Federal Housing Administration. That means a jumbo mortgage is not backed in any way by the government. But a Google search will return dozens of offers. In other words, government backing is not necessary in order to make this loan available to homeowners.

When confronted with this fact, proponents of government mortgage guarantees will argue that these jumbo fixed-rate mortgages--because they don't have government backing--are more expensive than those available from Fannie and Freddie.

This is true. The 30-year, fixed-rate mortgages offered by Fannie and Freddie are somewhat less expensive (recently about .5%) than those offered by banks and others without government backing. But that is only because the taxpayers are subsidizing this loan. That subsidy is hidden most of the time, except when--as now--Fannie and Freddie become insolvent and the taxpayers' subsidy becomes all too visible.

So, one might ask: Is this kind of mortgage loan such a good deal for homeowners that it makes policy sense to have the taxpayers take the losses that inevitably seem to flow from government guarantees? The answer is clearly no.

Analyses of the 2008 financial crisis almost uniformly note that housing price declines were particularly destructive because so few homeowners had substantial equity in their homes. This gave rise to many foreclosures and to strategic defaults, where homeowners walked away from homes that were worth less than the mortgage--i.e., when they were "underwater."

This brings us to the 30-year, fixed-rate mortgage. This loan amortizes principal very slowly. It is popular because it maximizes the benefits of the mortgage interest tax deduction and keeps the homeowner's monthly payment low. But it also means that homeowners accumulate equity in their homes very slowly. Most of the monthly payments are interest (very little is principal) for many years.

Following the enactment of affordable housing standards for Fannie and Freddie in 1992, mortgage underwriting standards deteriorated in this country. As I argued in my dissent from the recent report of the Financial Crisis Inquiry Commission, it seems to have been a deliberate policy of the Department of Housing and Urban Development to reduce mortgage standards and down payments in order to assure that mortgage credit was available to a wider section of the U.S population. By the late 2000s, more than one-third of all new mortgages had down payments of 3% or less. Here, too, homeowners have very little equity in their houses at the outset. And building equity takes longer in the case of 30-year, fixed-rate mortgages.

We should have no objection, of course, if homeowners want this type of loan. That's certainly their right. The question is whether the taxpayers should subsidize them.

Peter J. Wallison is the Arthur F. Burns Fellow in financial policy studies at AEI.

Photo Credit: iStockphoto/Henrik Jonsson

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