A fixed-rate conventionally-amortized mortgage is the least risky kind of mortgage obligation. If borrowers can make their payment, a payment that will not change over time, they can keep their home. At the end of a predefined term, the original funds have been paid in full, and the loan is discharged.
After World War II a series of government programs to encourage home ownership spawned a surge in construction and the evolution of private lending terms resulting in the 30-year conventionally amortized mortgage. This mortgage generally required a 20% downpayment, and allowed the borrower to consume no more than 28% of their gross income on housing. These conservative terms became the standard for nearly 50 years. Lending under these terms resulted in low default rates and a high degree of market price stability.
There were experiments with various forms of exotic financing during this period, particularly in markets like California where price volatility required special terms to facilitate buying at inflated pricing. The instability of these loan programs was demonstrated painfully during the deep market correction of the early 90s in California characterized by high default rates and lender losses.
In residential mortgages, a 30-year term is most common, but if bi-weekly payments are made (two extra per year), the loan can be paid off in about 22 years. If borrowers can afford a larger payment in the future, they can increase the payment and amortize over 15 years and pay off the mortgage quickly. Few people actually do this despite the obvious benefits.
The best way to deal with unemployment or other loss of income is to have a house that is paid off. Stabilizing or eliminating a mortgage payment reduces the risk of losing a house or facing bankruptcy. Unfortunately, payments on fixed-rate mortgages are higher than other forms of financing, so borrowers often opt for the riskier alternatives.
Exotic loan financing terms became widespread during the housing bubble. These terms proved to be unstable, and many borrowers defaulted on their loans. As more and more people defaulted, the lenders stopped lending money under these terms, and real estate values plummeted. Of course, this caused even more people to default, and prices fell into a downward spiral. Lower prices distressed more homeowners who went into foreclosure which drove prices even lower. None of this would have happened if fixed-rate conventionally-amortized mortgages were the norm rather than the exception.
Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: http://www.thegreathousingbubble.com/
Read the author’s daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/
[tags]housing, real estate, buying real estate, housing bubble, real estate bubble, house for sale[/tags]
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