History of the 30 Year Fixed Rate
But exactly what is the history of the 30 year fixed rate mortgage and why is it important?
Prior to the New Deal introduced in the 1930s, mortgage loans were of a shorter term and issued primarily by private banks. Banks don’t like to keep their money tied up long term if they can help it. That’s why prior to the 1930s mortgages were issued in shorter terms, say in just a matter of a few years. In fact, banks could call in their loans mostly any time they wanted to, regardless of the term remaining on the mortgage.
FHA loans however changed all that when the program was introduced. These new programs established not only a universal 30 year loan period but also stipulated that a lender could no longer call in a mortgage without due cause. Prior to the introduction of the 30 year FHA program, a bank could call in a loan simply because market rates had gone up and they wanted a higher yield.
This new 30 year guideline was actually good for the consumer as well as for the lender. When a lender issued a mortgage it was easier for them to manage their risk in the housing market. Knowing what return the lender was going to receive, consistently and over an established period, allowed for better money management.
But what it did for the consumer was far better. A 30 year fixed rate mortgage is just that…it’s fixed. The mortgage rate will never change. In addition, the loan is fully amortizing, meaning that with each payment a portion of the principal balance as well as interest due is paid, which means the loan will be fully paid off after 30 years.
Because of this uniformity, the 30 year fixed rate mortgage became the standard that all mortgage lenders soon followed.
This uniformity of the 30 year fixed rate mortgage also has another benefit: lower rates to the consumer as set forth not only by FHA but also Fannie Mae, Freddie Mac, the VA and USDA programs.
If 30 year fixed rate loans are underwritten to the same lending guidelines that all lenders follow then in essence the 30 year mortgage is a commodity, freely bought and sold on the secondary market. And that’s exactly what lenders can do…buy and sell mortgages to one another as well as to Fannie Mae and Freddie Mac.
A commodity can be defined as a product that can be freely bought or sold with the only distinguishing factor being price. And if there is more of a commodity than less in the open market, the price of that commodity is held low.
This universality can be compared with its opposite cousin, the “portfolio” loan. A portfolio loan is a loan issued by a lender that conforms to its own internal guidelines and not underwritten to FHA, Fannie Mae, Freddie Mac or any other established guideline.
While a lender certainly has the right to do so the portfolio loan cannot be bought or sold in any other market. The loan has to remain in the lender’s own “portfolio” of mortgages. When a loan can’t be sold to others the lender will increase the interest rate to offset the unique characteristics of the portfolio loan.
When lenders have the very same loan product, then one of the things they absolutely must compete on and that is the price, or the rate, on the loan. This competition over the helps to keep interest rates low.
The 30 year fixed rate mortgages is the most popular loan choice from the Great Depression until today. They’re predictable as well as common. And those two features are the main reasons the 30 year fixed rate mortgage is the loan of choice from Boston to Miami and all points in between.