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Why the 20-Year Mortgage Is the Answer to Housing Finance Mess

A recent Associated Press poll found more than six in 10 respondents expressed only slight confidence — or none at all — in the ability of the federal government to make progress on important issues facing the country.

The public's skepticism is well founded, especially when it comes to federal housing policy. Notwithstanding an alphabet soup of government agencies and federally backed companies — Federal Housing Administration, Fannie Mae, Ginnie Mae, Freddie Mac, Federal Housing Finance Agency, etc. — and trillions spent on government-mandated "affordable housing" initiatives, our homeownership rate today is no higher than it was in the mid-1960s. What is best described as a nationalized housing finance system has failed to achieve its two primary goals: broadening homeownership and achieving wealth accumulation for low- and middle-income homeowners.

The U.S. homeownership rate as of the fourth quarter of 2015 is 63.8%, the same as in the fourth quarter of 1966, and only marginally higher than the rate in 1956. More troubling, our housing policy has been unsuccessful at building wealth — the antidote to poverty. Between 1989 and 2013, median total accumulated wealth for households in the 40th to 60th percentiles has decreased from $76,100to $61,800, while median wealth for households in the 20th to 40th percentile has decreased by more than 50%, from $44,800 to $21,500. It was precisely these groups that were targeted to be helped by affordable housing policies.

For the last 60 years, U.S. housing policy has relied on looser and looser mortgage lending standards to promote broader homeownership and accomplish wealth accumulation, particularly for low- and middle-income households. Leverage first took the form of low down payments combined with the slowly amortizing 30-year term mortgage, which resulted in rapidly accelerating defaults, foreclosures and blighted neighborhoods. Since 1972, homeowners have suffered between 11 million and 12 million foreclosures. During the 1990s and early 2000s, new forms of leverage were combined with declining interest rates. With demand increasing faster than supply, the result was a price boom that made homes less, not more affordable, necessitating even more liberal credit terms. We are all familiar with the outcome—a massive housing bust and the Great Recession.

Today, in the shadow of Fannie and Freddie's continued existence, taxpayers are again driving home prices up much faster than incomes — particularly at the lower end of home prices. U.S. housing policy has become self-justifying and self-perpetuating — loved by the National Association of Realtors, many housing advocacy groups, and the government-sponsored enterprises, but dangerous to the very homebuyers it is supposed to help.

To help achieve sustainable, wealth-building homeownership opportunities for low- and middle-income Americans, our current government-backed command and control system should be replaced with market-driven antidotes. For most low- and middle-income families, the recipe for wealth-building over a lifetime contains three ingredients: buy a home with a mortgage that amortizes rapidly, thereby reliably building wealth; participate in a defined contribution retirement plan ideally with an employer match; and invest in your children's college education.

Here are three steps to make the first goal — quickly amortizing mortgages — more of a reality:

First, housing finance needs to be refocused on the twin goals of sustainable lending and wealth-building. Well-designed, shorter term loans offer a much safer and secure path to homeownership and financial security than the slowly amortizing 30-year mortgage. Combining a low- or no-down-payment loan with the faster amortization of a 15- or 20-year term provides nearly as much buying power as a 30-year FHA loan. A bank in Maine offers a 20-year term, wealth-building loan that has 97% of the purchasing power of an FHA-insured loan. By age 50 to 55, when the 30-year-term loan leaves most homeowners saddled with another decade or more of mortgage payments, the cash flow freed up from a paid-off shorter-term loan is available to fund a child's post-secondary-education needs and later turbocharge one's own retirement.

Second, low-income, first-time homebuyers should have the option to forgo the mortgage interest deduction and instead receive a one-time refundable tax credit that can be used to buy down the loan's interest rate. Borrowers who participate in a defined contribution retirement plan might receive a larger tax credit, enabling them to lower their rate even more.

The one-time tax credit would support wealth-building by being available only for loans with an initial term of 20 years or less. To avoid pyramiding subsides and reduce taxpayer exposure, only loans not guaranteed by the federal government would be eligible. This would provide a big start to weaning the housing market off of government guarantees. With the Low-income First Time Homebuyer — or LIFT Home — tax credit in place, the Fannie and Freddie affordable housing mandates could be eliminated, ending the race to the bottom among government guarantee agencies. Reductions in the Department of Housing and Urban Development's budget and other budgeted amounts supporting "affordable housing" should also be used to fund LIFT Home. Better to provide the dollars directly to prospective homeowners, than to be siphoned off to bureaucracies and advocacy groups.

Third, the home mortgage interest deduction should be restructured to provide a broad, straight path to debt-free homeownership. Today's tax code promotes a lifetime of indebtedness by incenting homeowners to take out large loans for lengthy terms so as to "maximize the value" of the deduction. Current law should be changed to: limit the interest deduction for future home buyers to loans used to buy a home by excluding interest on second mortgages and cash-out refinancing; for future borrowers, cap the deduction at the amount payable on a loan with a 20-year amortization term; and provide a grandfather on the deduction cap for existing home loan borrowers with 30-year loans as long as their interest savings go toward shortening the loan's term.

A 21st-century market approach to wealth-building offers a safe and secure path to homeownership and financial security, something we haven't had for decades.

Edward J. Pinto is a resident fellow at the American Enterprise Institute and co-director of AEI's International Center on Housing Risk.


(2) Comments



Comments (2)
Well stated technoscribe. You encapsulated it best by stating; a mortgage is little more than an agreement to maintain wealth...for someone else. The mortgage - promissory note - is the asset and that's what the banks are in business to do; create sellable assets...we all get it...its the model by which the whole machine is built and fed.

Does anyone ever consider that maybe its the model...these amortized loans...that are creating the destruction of the system itself? If the Great Recession taught us anything it should have taught us to take a closer look at the model we are participating in. Building wealth thru a shorter termed mortgage? Won't happen. Can't happen. People have been trying since the '60's. They've failed because of the conventional model of banking and borrowing. No disrespect to the banking are operating the most successful business model ever devised...but you have the tools in place to maintain if not increase your profitability and help create the 'dream' as described above for all consumers. You can do this WITHOUT changing your model. Just change the model for the consumer with the products and services you ALREADY offer. You just need to know how to implement a new campaign. A consumer CANNOT build wealth in a model that does not support wealth creation for the consumer. You have to change the model...for the consumer.
Posted by Bill Westrom | Monday, February 08 2016 at 3:17PM ET
The current mortgage system is designed to build wealth -- for the banks and the landed gentry of the modern "investor class." The major lenders have recorded record profits in the aftermath of mass foreclosures (over 3 million since 2008). The mechanics behind this counter-intuitive result are opaque and complex, but the intent is pretty obvious: harvest any wealth created by the lower and middle class through any means necessary. This is at the core of the "wealth transfer" we hear about in the analytical work of analysts such as Krugman and Stiglitz. I doubt that such a complex system can be reversed by the introduction of simple 20 year fixed mortgage. Personal example: I paid in $72,000 on a $144,000 loan over 6.5 years, and the house was then sold for $122,000 in a distressed "short sale." The bank made around $50,000 on the deal, and I walked away with nothing more than a destroyed credit rating. At this point, it seems a mortgage has become little more than an agreement to maintain a bank's asset in exchange for some temporary housing. We're just the help. The bank will keep the wealth -- as some higher power intended, no doubt. A tax break used to buy points is kind of a bad joke in this modern context. The LIFT will require a far more substantive reconstruction of a thoroughly "gamed" system. In the meantime, I will be content to rent, and let those who are building their wealth carry some of the headaches (and some of the latent risk) that go along with that process.
Posted by teknoscribe | Saturday, February 06 2016 at 9:49AM ET
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