Why Do We Have Mortgages Anyway?
Why? And are they truly good for low-income folks? (Spoiler, they’re terrible).
Brief pieces about getting business right.
Many people, including myself, have been raised to believe that ownership of a single-family home is both a worthy financial investment and a sign of societal success. Young generations are taught by parents and subliminal messaging to learn, work, and save to afford a down payment on a single-family home. A March 2022 Bankrate.com survey cited homeownership as a top indicator of financial success for 65% of millennials. However, an obsession with homes is not uniquely American. Turmoil in the Chinese housing market remains top of mind; the societal status factor or ‘peer pressure’ motivation of owning a home drove many desperate Chinese citizens to invest in homes at inflated prices far above their reasonable financial means. Chinese culture dictates that men should own a home before marrying. Their housing market represents a more extreme version of what’s happening in America right now.
But this is not a historical norm — the current expectation of homeownership through long-term financing is a big exception. Not to say that homes were never important before. Property and homeownership have historically been two of the most important factors of financial success and societal dominance, and they continue to be important today for the same reasons. The problem is that people expect more expensive homes now.
Homes used to be cheaper: they had fewer things on, around, and inside that made them expensive. No septic systems, no central air conditioning, etcetera. Homesteads on farmland generated wealth through livestock or produce. Houses in rural areas tended to be passed down through generations. Additionally, productivity growth in consumer materials markets outpaced productivity growth in construction, making houses comparatively more expensive to construct over time (construction is labor-intensive, leaving it as an exception in financial markets that have generally grown to expect efficiency increases and automation). According to US census data, the median home price in 1940 was just $2938, or $62,500 adjusted for inflation. Today, the median home price is $455,000, up from $165,000 in 2000 (FRED).
“Homes used to be cheaper: they had fewer things on, around, and inside that made them expensive.”
Over the period between 1940 and today, wage growth has not kept up with housing prices, turning the expectation of owning a home from being well within the means of an ‘industrious worker’ to being far above the means of most young people today. Normal assumptions about supply and demand would dictate fewer homes demanded at higher prices, but this is not the case. A higher percentage of the population owns homes now than ever before. Thus, long-term mortgages have become increasingly important to cover the price gap, fueled by the government’s stabilization of the housing market in response to the Great Depression (they subsidized fixed-rate (FRM), long-term mortgages).
By the 1970s-80s, FRMs and lax lending restrictions allowed more low-income households to buy expensive suburban homes outside their financial means, coinciding with significant marketing campaigns, backed by banks, that popularized suburban homeownership as being part of the ‘American Dream’. It was hip and cool, they told low-income young people, for them to sell their generational family homes and move to expensive suburban, mortgage-backed houses that had more amenities like central air conditioning, but which would leave them virtually enslaved to their interest payments. Others were told that homes were worth the interest payments as an investment tool. The Community Reinvestment Act by President Jimmy Carter in 1977 basically penalized banks that didn’t give a certain percentage of their mortgage loans to low-income households who didn’t qualify. It seems that banks played a large role in popularizing the notion that all households needed to be homeowners, incentivized by both the aforementioned political doctrine as well as more rudimentary financial motivations to promote mortgages during this time. By the mid-1990s, increasing homeownership became an even clearer public policy position supported by Presidents Clinton and Bush. Although it’s true that homeownership does sometimes provide a decent return (by either property values increasing or through rental income), households using a mortgage-backed home to live in instead of as an investment property see the majority of those returns counterbalanced by the mortgage’s interest more often than not. Remember, modern homes don’t earn cash flows from agricultural production, either. So there is a plausible argument to be made that the modern emphasis on homeownership through a long-term mortgage is more of a cash cow for banks than it is a benevolent public policy or a wealth-building tool for households. A related discussion is about opportunity cost and information: whether low-income homeowners are well-informed and truly willing to pay the mortgage’s interest to own a home, or whether they don’t know what they are missing by choosing such interest-heavy housing options.
Are adjustable-rate mortgages (ARMs) better than FRMs? Are they the solution to all of America’s housing problems? It depends on whether rates increase or decrease. People using ARMs bet on interest rates falling after purchase. If inflation continues to drive up interest rates, FRMs will prevail. But in the end, does it even matter? They are slightly different versions of the same system. Both, when coupled with loose lending, enable households (especially low-income ones) to spend above their means and tie up inordinate percentages of their buying power into investments with no cash flows.
