Chapter 4 Residential Mortgage Financing in the United States © OnCourse Learning.

Chapter 4

Residential Mortgage Financing in the United States

© OnCourse Learning

2© OnCourse Learning

Chapter 4 Learning Objectives

Understand how residential lending evolved from the earliest of times through World War II

Understand how forces in the economic environment, especially inflationary factors, resulted in changes in both the types of institutions writing mortgages and the types of mortgages available.

Understand the development of residential mortgage lending through time


Pre-Americans Developments

Roman Law Initially the instrument used in RE loans was termed “fudicia” which provided that title and

possession of the property be held by the lender until repayment.

“Pigus” – title and possession remain with the borrower; no transfer of title. Lender could take title and possession under “a suspicion of the probability of default.”

“Hypotheca” – similar to “pigus;” No transfer of title or possession. Lender could take title only under actual default.



German Influence German law recognized the concept of “gage” – a deposit made to fulfill an agreement

Borrower could physically deliver portable property as a gage – “live gage.”

Real property (not transportable) – a “dead gage.”

In case of default when collateral was dead gage the lender could take possession, but could not look beyond the gage for relief.



English Developments Gage system introduces in 1066.

Dead gage in French – mort gage.

Concept of usury in that charging interest was sinful

Equitable right of redemption - allowing borrower to redeem the property after default

Equitable right of redemption used today in all states

Some states, by statute, grant an additional period of time during which the mortgagor can redeem the property – statutory right of redemption.


American Residential Finance – Early American History

U.S. law is a mix of Roman, German and English law

Early expansion Little need for lending

Some building societies formed to consolidate funds for home buying

Post-Civil War Increased mortgage lending to finance westward expansion

Typical loan was short-term, interest-only (called nonamortizing) and covered 40 – 50% of the value of the property


American Residential Finance – Early American History

Early 1900s through 1920s Federal Reserve in 1913 allowed banks to write 5-year, 50% loan-to-value ratio, non-

amortizing mortgages

During early 1920s building and loan associations expanded rapidly

During early 1920s real estate prices rose rapidly

After 1929 market crash, real estate prices dropped dramatically


American Residential Finance – Early American History: 1930s Market crash in 1929 ushered in the Great Depression

Property values fell to about half of the 1928 level.

Banking system collapsed, money supply plummeted, unemployment soared

Refinancing short-term, non-amortizing loans became a problem

American Residential Finance – Early American History: 1930s Many states passed legislation enacting moratoriums

on foreclosures. A number of federal agencies created including

Reconstruction Finance Corporation (RFC in 1933); Federal Home Loan Bank System (FHLBS, 1932),Home Owners Loan Corporation (HOLC, 1933), Federal Savings and Loan Insurance Corporation (FSLIC, 1934), Federal Housing Administration (FHA, 1934), and Federal National Mortgage Association (FNMA or Fannie Mae, 1938).



Modern Residential Finance – The 1940s Preoccupied with World War Two

Veterans Administration created

The Veteran’s Administration was given authority to develop a mortgage insurance program, similar to that of the FHA.


Modern Residential Finance – The 1950s Decade of S&L expansion and stability S&L associations enjoyed greatest growth in mortgage

lending; commercial banks’ share in mortgage lending declined, but recovered in the 1980s.

In 1950s over 50% of all mortgage debt was held by depository institutions

Modern Residential Finance – The 1950s Large difference between the maturity of the

institution’s assets and liabilities due to wide acceptance on the 30-year fixed-rate mortgage –maturity mismatch Increased interest rate risk because of fixed-rate mortgages Problem exacerbated by the lack of prepayment penalties

on mortgages. Due to stable inflation and interest rate environment,

maturity mismatch was not a serious problem



The 1960s: Inflation, Disintermediation and Rise of the Secondary Mortgage Market

Period of rising inflation up to 6.1 % in 1969. Treasuries – attractive investment alternative due to

high Treasury yields.

The 1960s Disintermediation in 1966 (during the “credit crunch”)

and 1969 Thrifts’ rate significantly lower that the yield on short-term

Treasuries In 1968 the Truth in Lending Act passed to assure a

meaningful disclosure of credit terms and costs allowing borrowers to avoid abuse lending practices and shop for mortgages

Development of secondary mortgage market – securities and bought and sold after their origination


The 1970s: FRMs in an Inflationary Environment By 1979 inflation rate reached 13.3%; Increased

volatility of the annual rate of inflation Demand problems: Rise in long term rates →less

affordable mortgages → real mortgage cost increased in the early period of the loan and decreased in later part – “tilt” effect

Supply problems: maturity mismatch structure of financial intermediaries.


The 1970s Introduction of alternative mortgage instruments (AMIs)

Graduated-payment mortgage (GPM) – lower initial payment; initial negative amortization

Shared appreciation mortgage (SAM) Adjustable rate mortgage (ARM) Price level adjusted mortgage (PLAM) – initial rate = real rate

Continued growth of the secondary market Fannie Mae and Freddie Mac continued to grow and by 1980

held or guaranteed >1/5 of all mortgage debt outstanding



1980s: Deregulation, Growth in AMIs and Thrifts Crises Depository Institutions Deregulations and Monetary Control

Act (MCA) passed in 1980 Removed rate ceiling on some deposits

The Garn-St. Germain Act (1982) introduced competition and incentives for risk-taking

The 1980s FSLIC forbearance by allowing troubled institutions to

continue to undertake risky investments Financial Institution Reform, Recovery and

Enforcement Act (FIRREA) passed in 1989 Widespread S&Ls failures due to deregulation and

maturity mismatch issue.


1990s: The Dominance of the Secondary Mortgage Market

Domination of government-sponsored enterprises (GNMA, FNMA and FHLMC) and secondary mortgage market

Increased share of mortgage bankers in mortgage originations

Increased standardization of loan documents and evaluation processed


The 1990s Baby boomers trading up increasing demand for up-

scale housing Mortgage lending – national in scope Low mortgage interest rates – refinancing “craze” In 1995 risk-based guidelines expanded to cover

interest rate risk.


2000s: Period of Extremes Housing market craze in the 2000s – Single-family homes

entered the speculative investment market Mortgage lending standards relaxed By 2006, housing prices have risen >80% from their 2000 level. Rapid growth of secondary mortgage market through Fannie

Mae, Freddie Mac, and Wall Street Aggressive buying of subprime and Alt-A mortgages and MBS

by Fannie Mae and Freddie Mac.


2000s: Period of Extremes

In 2007 sharp drop in prices across the US – due to weakening economy and high inventories of unsold homes.

Rising delinquencies due to negative equity and large subprime market

Collapse in 2008 of several Wall Street investment firms and take over of Fannie Mae and Freddie Mac by the government.

Changing market as house prices fell and lenders tightened standards

© OnCourse Learning 22

2000s: Period of Extremes (2007-2012) Borrowers began to show willingness to walk away

from speculative housing investments S&P downgraded large number of residential

mortgage securities as toxic mortgage debt poisoned the global financial system

Rebound in housing prices in the end of the 2000s decade; historically low interest rates


Chapter 4 Residential Mortgage Financing in the United States © OnCourse Learning.

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