While the housing bubble left the U.S. in one of the worst financial crises in recent memory, the 30-year fixed rate mortgage might have actually saved the housing market, according to recent report by Bloomberg News.
Since many mortgages of the 1920s were “balloon loans” with terms of just three to five years, writes Bloomberg, homeowners could not refinance their mortgages when investors stopped buying mortgage bonds after the 1929 crash.
While private capital piled up in banks that were “too afraid to lend,” in 1934, President Franklin D. Roosevelt paved way for the Federal Housing Administration (FHA) to introduce a new plan that would change the way Americans borrowed.
FHA’s plan was that the federal government would organize an insurance pool, however, it would not fund it. Instead, lenders would contribute to the “pool” and would receive payment from it in the event of a mortgage default.
Payments would typically be in the form of a low-yielding bonds, where the lender would not lose the principal of the mortgage.
“With such long repayment period, the monthly installments could incorporate both interest and principal,” writes Bloomberg.
Mortgage amortization, as it became known, did away with the need for the refinancing that was so commonly associated with the short-term loans of the time.
As a result of FHA’s innovation, homeowners could borrow for 15 or 20 years, the thinking behind it being that these loans could provide market stabilization that had not yet existed in the years prior to the crash of 1929.
Written by Jason Oliva