Purchasing a home is not an impossible pursuit for most Americans, thanks to a multitude of programs and services available to assist in the process. Central to home buying is the mortgage, a financial arrangement between the lender and the consumer. Mortgages come in many forms that can fit the needs of the buyer over the short and long terms. This paper will explore the myriad of mortgage products that are available for consumers who seek to purchase land and/or a home of their own.
Keywords: Adjustable Rate Mortgage; Conventional Mortgage; Fixed-Rate Mortgage; Fannie Mae; Freddie Mac; Interest Only Mortgage; Reverse Mortgage
In the 19th century, Americans, who had heavily populated the eastern coastline of the country, began moving into the wide open frontiers of what is now the midwest and west coast of the United States. Over time, much of the new territories were surveyed and plotted, while others were yet undiscovered. There were a number of reasons for this westward migration, but chief among them was the promise of land and the ability to build a new home. Eventually, even Europeans and other international travelers joined the pursuit of inexpensive and even free land on which they could build their homes and farms. Of course, the American dream of land ownership led to a rapid settling of the frontier. Historian Frederick Jackson Turner put it succinctly at the end of the 19th century: "What the Mediterranean Sea was to the Greeks … the ever retreating frontier has been to the United States … at the end of a hundred years of life under the Constitution, the frontier has gone" (Turner, 1893).
The land grabs and wagon trails of the 19th century may now be a part of history for a nearly fully developed 21st century America, but the dream of ownership of land and a home remains as strong today as it did then. Still, there are obstacles that present as great a challenge for the would-be homeowner such as financing, home inspections, credit and copious paperwork. For many, these challenges are as daunting as the harsh weather, wildlife and the planting of crops on the 19th century frontier.
Purchasing a home is not an impossible pursuit for most Americans, thanks to a multitude of programs and services available to assist in the process. Central to home buying is the mortgage, a financial arrangement between the lender and the consumer. Mortgages come in many forms and offer a wide range of products that can fit the needs of the buyer over the short and long terms. This paper will explore the myriad of mortgage products that are available for consumers who seek to purchase land and/or a home of their own.
A Look at Mortgages
Derived from an old French term meaning "dead pledge," a mortgage is technically a security for a loan that is used (usually) to finance the purchase of real estate. Mortgages have a defined life expectancy with specific terms of payment and interest rates. Mortgages have been in existence for more than 800 years, dating back to late-12th century England, in which common law allowed the creditor to have an interest in the property of the individual who borrowed his or her money. Mortgages became increasingly popular during the latter 19th century, when more and people were purchasing land and building homes for their own. The mortgage system was not ideal for every consumer, however, as most people who received a mortgage had to pay a 50% down payment in order to receive the mortgage.
When the Great Depression began in 1929, mortgages virtually disappeared, as creditors had no money to lend and consumers had no money to put into a mortgage. However, as part of his New Deal, President Franklin Delano Roosevelt in 1934 created the Federal Housing Administration (FHA) to protect lenders from default. In addition to giving mortgage providers greater security (thereby enticing lenders to provide more programs), the FHA introduced the concept of a 30-year fixed rate mortgage, which helped homeowners repay their loans over a longer time.
The FHA's creation helped spur an increase in lending, although issues remained. Chief among them was the fact that the spike in lending meant that some financial institutions did not have the money to meet such demand. Adding to the issue was the fact that terms and interest rates were inconsistent due to the fact that they were linked to local economies and trends rather than a federal standard. To address these issues, the federal government created the Federal National Mortgage Association, better known as "Fannie Mae" in 1938. Fannie Mae bought loans owned by FHA and sold them on the markets as securities, which helped generate additional revenues to add to the FHA's coffers. Additionally, Fannie Mae helped create uniform standards, loan terms, interest rates and guidelines (Marples, 2008). Post-war mortgages spiked over the next few decades, leading the federal government to create another institution, the Federal Home Loan Mortgage Corporation (called "Freddie Mac) to address even greater funding needs. Freddie Mac helped increase the flow of mortgage funds to commercial banks, credit unions and other financial institutions to be distributed among consumers.
Over the course of the 20th and the early 21st centuries, mortgages and lending practices have evolved considerably. This evolution is due to the considerably larger volume of people who pursue home ownership. To meet the demand of a socially and economically diverse population, mortgage providers have consistently sought the best mortgage products to present to their clients.
About 35 to 50 percent of all mortgages in the US are what are identified as conventional mortgages. Also known as "conforming loans", conventional mortgages are loans that meet the standards and criteria of Fannie Mae or Freddie Mac.
Conventional mortgages have long enjoyed a considerable degree of popularity among home buyers. They are expensive, to be sure, as such loans require a 15-20 percent down payment. Then again, such high down payments also ensures early equity, an effective defense against a poorly performing housing market. Additionally, conventional mortgages offer some of the lowest interest rates on the market, particularly in comparison to those secured by government lenders (Kerr, 2009). For those who can afford them, conventional mortgages offer a great deal of stability and security, particularly in an uncertain economic climate.
In general terms, conventional loans may be seen in two forms. The first is a fixed-rate mortgage (FRM). As the name suggests, fixed rate mortgages retain a locked-in interest rate over the life of the loan, which is determined upon the finalization of the agreement. Generally, these types of loans are on a 15- and 30-year basis, giving the consumer a formal framework in which to repay.
The obvious benefit of an FRM is stability, a factor that is extremely relevant in times of fiscal and economic uncertainty. The worldwide recession that began in 2007, for example, saw plummeting housing sales and stagnant construction, leading to a drop in interest rates. By early 2009, however, the economy was slowly recovering, and interest rates began to increase once again ("Economic ups and downs," 2009). Consumers with fixed-rate mortgages saw none of this flux in their own loan repayments, as their interest rates remained locked and their payments, therefore, consistent.
For some consumers, however, the consistency of an FRM also...
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