The Problems With Mortgage Financing

In a post called, Critique of the Mortgage Program, and another one, Is Homeownership Still a Good Idea, I laid out concerns about long-term, 30-year mortgages. Also, I suggested that It is Time to Start Winding Down the Federal Home Loan Banking System. But a Bankrate survey from a couple of years ago found that “fully 74 percent of Americans consider homeownership a key component of the American dream,” and people answering that survey “placed a higher value on it than on any other indicator of economic stability, including a comfortable retirement, a successful career and a college degree.” But shouldn’t we also consider the costs?

Inflation

One of the biggest problems with the long-term, 30-year mortgage is that the interest is frontload. A pearl clutching Harvard Magazine article bemoaning the apparently outrageous housing inflation in Boston over the last 40 years cites the fact that a home there in 1995 cost $165,000 and now costs $714,000. The article points out, too, that “For someone taking out a conventional fixed-rate 30-year mortgage, the monthly carrying costs (assuming a 10 percent down payment but excluding closing costs, taxes, and insurance) would have risen fourfold, from $1,029 to $4,181, leading to payments over the life of the loan totaling more than $1.5 million.”

But this is a feature not a glitch of the mortgage. What might cause outrage for some is a boon for others. The household that purchased that house in Boston in 1995 built a whole bunch of wealth, right? Never mind the costs over time and the fact that to achieve such appreciation Boston needed a “housing crisis,” caused by sclerotic permitting and bad land use policy cited by the article. This is why the 30-year mortgage mints so many NIMBYs year after year who resist relaxation of barriers to the market for new housing.

Then there are the demand dynamics caused by the availability of long-term fixed-rate mortgages which stimulate more people to enter the housing market and leading to increased borrowing. In markets with housing shortages, this heightened demand, coupled with ample credit supply, can drive up property prices, contributing to inflationary trends. It is the classic case of too many dollars chasing, in this case, too few homes.

Land Use

An analysis from the Department of Housing and Urban Development found that 86% of mortgages were for detached, single-family homes. A more recent look found just 10% of mortgages were for condominiums or cooperatives. Detached single-family homes need lots of land for fewer people. The American Dream has not typically played out in a two-bedroom apartment in a densely populated city. The resulting land use pattern is inefficient, leading to fewer people living in larger areas.

This has an impact on infrastructure and transportation. An older but still relevant study of land use patterns favoring the detached single-family home found that “Sprawl produces a 21% increase in amount of undeveloped land converted to developed land (2.4 million acres) and approximately a 10% increase in local road lane-miles (188 300). Furthermore, sprawl causes about 10% more annual public service (fiscal) deficits ($4.2 billion) and 8% higher housing occupancy costs ($13 000 per dwelling unit).” When units are farther apart, roads, water lines, electricity, and sewers have to be extended – and so do bus and train lines. All of this adds up and requires expenditures from the tax base for construction and maintenance, a tax base made up of more than just the single-family homeowners. This means while single-family homeowners are building equity, a fair share of that is subsidized by renters paying taxes for infrastructure.

Disparities

A report from the Treasury Department says it best. “The benefits from homeownership have not been shared equally. In the second quarter of 2022, the homeownership rate for white households was 75 percent compared to 45 percent for Black households, 48 percent for Hispanic households, and 57 percent for non-Hispanic households of any other race. Like the overall racial wealth gaps, these gaps in homeownership rates have changed little over the last three decades.”

As I pointed out in one of the posts above, Black applicants, even those earning 120% of the Area Median Income (AMI), qualify for mortgages at a lower rate than white households earning the same amount. So, earning more money doesn’t necessarily mean getting a mortgage under the current system if the applicant is Black. And those Black households are more likely to face higher cost mortgages, greater risks for foreclosure, and distressed sales. One analysis found that “African Americans and Latinos were much more likely to receive high cost, high risk loans than white borrowers during the housing boom, even after controlling for credit scores, loan to value ratios, subordinate liens, income, assets, expense ratios, neighborhood characteristics, and other relevant variables.”

Risk

The Financial Crisis Inquiry Commission (FCIC) formed in 2010 to review the causes of the financial crisis of 2008 found that “”the collapse of the housing bubble—fueled by low interest rates, easy and available credit, scant regulation, and toxic mortgages—that was the spark that ignited” This isn’t a shocker, especially in retrospect. At the time however, it seemed like a boom time; money was cheap and qualifying was easy. Why not take the jump toward the “American Dream?” The concentration of risk at the federal level has some ironic results.

First, before the formation of the Federal Housing Administrations and the Government Sponsored Enterprise (GSE) of the Federal Home Loan Mortgage Corporation (FHLMC), or Freddie Mac, risk was shared more locally by building and loans. Neighbors and community members pooled their wealth and shared it – and the risk of making loans – with each other. That meant qualifying for a loan might be easier and when something went wrong, it was in the community interest to resolve the problem rather than foreclose. And with risk being closer to home, it would also be harder to make a risky loan knowing that the person would be living right around the corner and frequenting the same schools, churches, and other community institutions.

A conservative estimate of housing’s share of Gross Domestic Product is about 3 to 5% and as much as 18%. It is worth taking a look at how to reorder this significant part of the American and global economy. As I posted earlier, the mortgage isn’t the only way to create ownership of a home, only the most recent. We need to look more closely at what we mean by ownership and whether there are better and more sustainable ways to achieve it.