How the 30-Year Mortgage Came to Dominate the Industry
A closer look at the history, appeal and future of the 30-year mortgage
When you take out a loan, you don’t normally pay it back next week or next month. You pay it back over a number of years, and those years can vary. Take home mortgages. The most recognized loan term for most Americans is 30 years. Interestingly, it’s not 40 years. Or 20 or even 15 years. Those loan terms exist but they don't retain the same popularity. For some reason, once government regulators of the mid-20th century unfurled the 30-year fixed rate mortgage, it was quickly seen as the most reasonable timeframe in which to pay back a home loan. And once the homebuying public embraced it, there was no turning back.
That said, you kind of have to scratch your head and wonder exactly why 30 years was and is still considered the go-to mortgage length (or “term” as it's known in the industry) by so many lenders and homebuyers across the U.S. Is there a magical financial formula that makes it so? Does it present a more sensible amortization schedule? Or is this popularly acknowledged sweet spot the optimal balancing act that satisfies money management issues on both the lender and borrower side?
Given its continued relevance in the housing market, now is a great time to take a closer look at the history of the 30-year mortgage; why it’s become such a popular and durable option for many homebuyers and how it can build generational wealth. We’ll examine why some well-off (and well-known) figures are such big advocates and conversely why some pundits think it’s a relic of the past that produces more than its fair share of interest payments. We’ll even evaluate the concerns of those who say that accelerations in climate change are poised to wash away the time-tested utility of the 30-year term.
A time before 30-year mortgages
The mortgage is not a recent invention. However, prior to the 1930s, obtaining a mortgage was not a straightforward, predictable process laden with consumer-driven options. To put it bluntly, borrowers were at the mercy of banks and variable interest rates.
Pre-New Deal mortgages
In the first few decades of the 20th century, borrowers typically had to provide up to a 50% down payment and were only issued short-term loans. Five years was the typical term.
In addition, the payments themselves were structured in particularly onerous ways. The 5-year mortgage would require you to make interest-only (or “interest-mostly”) payments for five years and then reach into your magic hat and pull out the necessary funds to cover the entire principal in the form of a lump-sum balloon payment—an arrangement that’s almost unthinkable today. However, most homeowners of this era never fully paid off their mortgage; they simply refinanced into another 5-year mortgage.
Notably, most loans were associated with variable interest rates. This made them a tricky proposition in a time when existing monetary tools to curb inflation were not aggressively leveraged. Given the high risks and exorbitant down payments, many Americans were effectively shut out of homeownership during this era.
Banks ruled the day
With an emphasis on liquidity, most commercial banks did not engage in long-term payment schedules that we commonly see today. That approach worked well enough for a while due to access to credit and the collective understanding that assets would continue to appreciate in value. But beneath the buzz, there were clear signs of a housing bubble.
When the stock market crashed in October 1929, panic and uncertainty reverberated throughout the banking industry, causing credit to significantly tighten and many homeowners to default on their loans. This disarray led to mass foreclosures and chaos throughout the housing sector—a problem that only accelerated during the next couple years. According to reports, 273,000 people lost their homes in 1932. The next year was even worse: Mortgages were being foreclosed at a rate of thousand a day.
Government help would be necessary to steady the ship.
Federal intervention and the 30-year mortgage
With the establishment of the Home Owners’ Loan Corporation (HOLC) in 1933 and then the Federal Housing Administration (FHA) in 1936, government entities were created to help stabilize the housing market, offer sensible refinancing to borrowers and protect lenders against losses they might otherwise suffer by offering them an early form of mortgage insurance.
Essentially acting as a federally sanctioned insurance company, the FHA was instrumental in guaranteeing loans, establishing uniform lending and appraisal standards, and promoting homeownership at a perilous time. It was one of the key institutions leading the country out of the Great Depression.
Longer loan terms
With approval from the FHA, mortgages were beginning to stretch out and depart from their previous model of 5-7 years. Suddenly, 15-year mortgages that were designed to fully amortize (in other words, if all scheduled payments are made on time the loan is paid off, resulting in full homeownership) were being issued, shortly to be followed by longer loan terms.
With new payment schedules now available to homebuyers and improved liquidity in the marketplace due to the 1938 creation of the Federal National Mortgage Association (Fannie Mae), lenders were willing to entertain longer loan terms, opening the door to increased homeownership.
The arrival and subsequent embrace of the 30-year mortgage
At first, it wasn’t at all clear the 30-year mortgage would dominate the marketplace. While the FHA cleared the way for its eventual arrival, 15- and 20-year mortgages initially held sway in this new era. In fact, the 30-year mortgage wasn’t officially authorized by Congress until 1948 (for new construction) and 1954 (for existing homes).
Given these facts, it’s not surprising that for much of the 1930s–1950s, the 15-year mortgage was the go-to option for many homebuyers. It was only when the Fed began raising interest rates in the mid ‘50s that it became abundantly clear to the FHA that a longer loan term could help offset these spikes. Homebuyers also appreciated the lower monthly payments that the 30-year model provided. Lenders however, took some persuading.
That’s why Fannie Mae (and later Freddie Mac) were so important to the success of the 30-year mortgage: Through buying and guaranteeing conventional mortgages, they all but eliminated lender risk, providing incentives to keep loans flowing out to homebuyers. Suddenly, 30-year mortgages were everywhere. And first-time homebuyers were the grateful recipients.
Since the early 1960s, the 30-year fixed rate mortgage has been the clear choice of most homebuyers across the country. There are ample reasons for this, including the following key benefits:
Key benefits of the 30-year fixed mortgage
- Lower monthly payments & access to homeownership
- Fixed payment = predictability
- Build intergenerational wealth
- Allows homeowners to save for other important purchases
- Built-in flexibility to refinance or pay down principal early (in most cases)
- Lenders are protected via Fannie, Freddie & Ginnie Mae
Lower monthly payments & access to homeownership
For many homebuyers, the greatest immediate benefit of the 30-year fixed mortgage is lower monthly payments. Homes are expensive, even modest ones, and if you’re going to be paying off your principal + interest + other associated costs (like taxes and homeowners insurance), you might need a way of reducing these payments by stretching them out over a longer period of time. This is precisely where the 30-year mortgage excels. Sure, lower payments mean more payments and more interest, but that’s not the chief concern here—access to homeownership is. And lower monthly payments are often the best way to manifest that.
Fixed payment = predictability
There’s something to be said about entering into a mortgage agreement where future payments will be highly predictable. If you choose an adjustable rate mortgage (ARM), you’re entering into a risky proposition, one defined by uncertainties. Not so with the 30-year mortgage. A clear amortization schedule is provided at closing, letting you know from the get-go how much interest you’re paying, how much equity you’re building and when exactly everything will be paid off, enabling you to join the ranks of full homeownership.
Build intergenerational wealth
When you pay down your principal in the form of monthly payments, you are building equity. Equity that allows you to borrow. Equity that allows you to pursue very reasonable HELOC and home equity loans. Finally, meeting all required payments over the life of your loan enables you to achieve full homeownership—and then eventually pass it on to a loved one, creating a clear throughline to intergenerational wealth.
Allows homeowners to save for other important purchases
When smaller payments are regularly made over the life of a loan, more money can be kept in reserve as savings to be deployed at a later date. Those savings can be tapped to help pay for college education, pay off other debts, use for a big purchase (like a new car or a vacation) or even invest in a small business or purchase stocks and bonds in your IRA. Having financial options is important to many people; a 30-year fixed rate mortgage allows you to tap these options.
Built-in flexibility to refinance or pay down principal early (in most cases)
Whether you love your current fixed rate or wish it were lower, nothing is forever with a 30-year mortgage. Modern life is about flexibility, and with most 30-year mortgages, there are ample opportunities to either refinance into a shorter loan term or pay off your principal early. While prepayment penalties used to be common, they are increasingly rare. It should be noted that if you pay off your loan early, you may still have to make required interest payments. Check with your lender for more details.
Lenders are protected via Fannie, Freddie & Ginnie
The other side of the coin—lender acceptance—is equally important in making the 30-year mortgage an attractive and readily available loan option. Because Fannie Mae and Freddie Mac are market-based guarantors for conventional loans, and Ginnie Mae serves as a government guarantor for VA, FHA and USDA loans, lenders who adhere to the approval guidelines set forth by these entities can make loans to homebuyers knowing that in the event of default, they won’t be left holding the bag. With abundant, ongoing liquidity evident in the marketplace, most lenders are more than happy to recommend 30-year fixed rate mortgages to prospective homebuyers.
30-year mortgage: Fans and foes
Predictably, there are those who really like and prefer the 30-year fixed rate mortgage, and those who think there are superior products on the market for homebuyers. Both camps make salient points.
Advocates of the 30-year mortgage
Millions of individuals and families have benefitted from the borrowing terms built into the 30-year mortgage. Most of them are everyday folks thrilled to have a shot at homeownership. Of course, there are others who are a little more financially well off. In the past few years, everyone from royalty to rap royalty have used 30-year mortgages to their financial advantage. But perhaps the best known advocate is businessman and investor Warren Buffet.
Buffet has famously stated that the 30-year mortgage is “the best instrument in the world,” due to the homebuyer's ability to refinance later and receive a lower rate. The “Oracle from Omaha'' has some personal experience. Buffet financed his Laguna Beach home purchase in 1971 with a 30-year fixed rate mortgage. He did this not because he couldn't afford to buy the property outright, but because he had superior places to put his money.
Said Buffet, “I thought I could probably do better with the money than have it be an all equity purchase of the house. I might have bought 3,000 shares of Berkshire or something like that… so that's [worth] $750 million [today]." It’s almost a case study on why opting for a 30-year mortgage is a great way to free up money that can then be used for other purposes. And yes, while Warren Buffet’s “other purposes” may be different than yours, the same reasoning applies: A 30-year mortgage gives you financial options.
A critical view of 30-year mortgages (and advocacy for the 15-year term)
Usually, critics of the 30-year fixed mortgage make an attempt to unfavorably compare it to the 15-year fixed rate. We get it. In a perfect world where everyone can meet increased monthly payments, it’s a great argument. Pay more each month, but pay less overall.
This is accomplished by a shorter amortization schedule that puts you on track to pay off the loan in half the time—which means half as many interest payments. Interest rates on 15-year mortgages are also lower than those for a 30-year loan. Appealing, right? Especially when that can mean tens if not hundreds of thousands of dollars saved in interest payments over the life of your loan.
Additionally, because you’re paying both more in interest and principal every month, you achieve equity at an accelerated rate. That means a faster route to full homeownership, and as a bonus, you can tap that rapidly accruing equity for a variety of home loans (if need be).
Once again, it all comes down to the homebuyer’s capacity to make higher monthly payments. Simply stated, that’s the deciding factor for many potential homebuyers: what can I afford? Sometimes a few calculations can throw everything into stark relief.
Wait—did someone say 40-year mortgage?
If you’ve been primarily wrestling with the pros and cons of both the 30- and 15-year mortgages, there’s a new option you might want to also consider if you’re financially distressed: the 40-year mortgage.
Essentially, the 40-year mortgage is designed to help homeowners currently in forbearance keep their homes by transitioning them into a longer loan term with lower payments. It’s not a refi, it’s what's called a “loan modification” and it will be extended by Ginnie Mae to homeowners who currently have an FHA, VA or USDA loan. While these federal agencies have yet to officially approve the 40-year loans, it is Ginnie’s intention to roll out this program in October of 2021. Currently, there are nearly 2 million loans in forbearance.
The hope is that lenders will make these terms available so people can remain in their homes and gradually get their finances in order after dealing with the unforeseen economic consequences brought on by the COVID-19 pandemic. Unlike the 30-year or the 15-year fixed rate mortgage, this is not a new offering for the general public, but rather a tool to be used if you’re nearing default and have no other option. More information can be found on the Ginnie Mae website.
Climate change and the future of the 30-year mortgage
According to a CBS report in 2019 and followed up by the New York Times in 2020, some industry and environmental experts think accelerations in climate change could potentially put the 30-year mortgage out of reach for a portion of homeowners in certain areas of the country.
Given the enormity of taxpayer funds that are already being directed to flood-prone areas like Southern Florida and Houston (in the wake of Hurricane Harvey) and numerous wildfire hot spots across Northern California, it shouldn't be surprising that, beyond the necessary disaster relief (a record $95 billion in 2020), there remain serious concerns going forward regarding what properties will be insured and for how much.
Taken one step further, if insurance companies refuse to underwrite policies, then the likelihood of obtaining a mortgage is almost nonexistent. Even Fannie, Freddie and Ginnie have to account for risk. Theoretically, the National Flood Insurance Program (NFIP) is there to pay out claims to homeowners and make lenders whole in the event of a flood-related disaster. But even the NFIP has its limits.
Some analysts have pointed out that requiring higher down payments is one way to reduce lender risk. But how realistic is that? The 30-year mortgage exists to make home financing affordable—not unaffordable. Going forward, you can be assured that this topic will be hotly debated. Ultimately, lenders, insurance companies, government sponsored agencies and the American homeowner will need to put their minds together, think outside the box and account for climate change one way or another.
Conclusion: 30-year mortgages are still a great instrument
Let’s be honest: Nobody asked for the 30-year fixed rate mortgage, not at first. No single financial expert predicted it would dominate the housing market the way it has over the last 60 years and provide a runway to homeownership for millions of Americans. And yet...here we are in the third decade of the 21st century, and despite critics and concerns, the appeal of this specific loan term shows no signs of going away.
Of course, all this talk of mortgage terms does beg the relevant question: Is the 30-year fixed rate right for you? Sounds like a simple question, but it really requires some number crunching—and some far-range thinking.
When looking into a mortgage for your new home (or when conducting a refi), your current financial situation will always come into play first and foremost. How much money are you earning and what can you afford right now, today? But beyond interest rates and credit scores, assets and income, you will want to envision your life over the ensuing decades and ponder how a choice of low monthly payments vs. high monthly payments will affect your quality of life.
Ultimately, this is the kind of conversation you’ll want to have with your lender. A trusted loan officer will be able to guide you through the mortgage process and make customized recommendations based both on your financial means and financial dreams.
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