Mortgage Products

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

Overview

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.

Fannie Mae & Freddie Mac

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.

Further Insights

Conventional Mortgages

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.

Fixed Rate & Adjustable Mortgages

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 means a lack of savings when interest rates are low. During times of economic stability and growth, interest rates often stay at lower levels. Consumers who select another conventional mortgage product, adjustable rate mortgages (ARMs), are able to reset their loan repayments based on the newly established interest rates and enjoy the subsequent savings on interest, focusing their payments instead on the principal.

The benefits and risks of each of these types of conventional mortgages are appreciated based on the needs and values of the consumers as well as the condition of the economy. As stated above, an adjustable rate mortgage may serve a consumer well during a non-recession year, while a fixed-rate mortgage owner would not see such savings unless he or she refinanced his or her loan. Then again, the tumult of a recession may cause ARM owners to refinance into a more stable FRM. In the spring of 2009, for example, interest rates had begun to drop from one-eighths to two-eighths of a point lower than in 2008. However, the impact of the recession on housing markets as well as the rest of the economy sent record numbers of consumers to refinance to an FRM — 99 percent of ARM borrowers who were refinancing did so under an FRM agreement. Adding to the incentives perceived by borrowers was that interest rates being offered on FRMs were comparable to the average interest rates of ARMs (Sinnock, 2009).

As noted earlier, conventional mortgages remain popular among consumers. However, they may not meet the needs and profiles of some buyers. Another mortgage product type has seen increased attention in the early 21st century.

Government-Sponsored Mortgages

Of course, not all people can afford to purchase a home, as a 20 percent down payment may not be feasible. For those on limited incomes, the federal government has mortgage products intended to open opportunity for potential borrowers who meet certain income and other requirements.

Government mortgages are not administered by the federal government, however. Rather, the FHA simply ensures the lender that the loan will be repaid if the borrower cannot do so. The decision to issue any loans is left to the private lender. However, there are guidelines that the government-sponsored mortgage contains that make it more attractive for those who cannot afford a conventional loan.

One such attraction is the fact that, rather than pay 20 to 50 percent down to secure the loan, FHA borrowers do not have much of a down payment to pay — in most cases, no more than three to five percent. FHA mortgages also do not have a value cap: FHA applicants can take out a loan of as much as $300,000 without any restrictions other than credit applications. Additionally, like conventional mortgages, FHA loans require the lender to pay closing costs, usually about two to three percent of the mortgage. However, unlike the conventional loan, these costs can be built into the mortgage and paid as part of the overall repayment schedule (FHA Research Center, 2009). Because FHA loans do not require a large amount to be used in the down payment, they have been increasingly popular among first-time home buyers and people in lower-income situations.

Fraud Concerns

Unfortunately, the demand for affordable housing through such mortgage products has opened the door for a high volume of fraud. In some cases, criminals take out so-called "zero pay" FHA mortgages (which require no down payment) and default on the loans upon closing. Between 2008 and 2009, some 9,200 FHA-insured loans went into "instant default," with one or even no payments made. The pace for such defaults in 2008 tripled the average volume during that year, setting a rate of more than 24 defaults every week (FHA 'zero pay', 2009). The prevalence of fraudulent mortgages has a severely negative impact on the FHA, the company assigned to back these loans. In light of the risks fraud poses for the FHA, widespread law enforcement efforts were initiated to combat this behavior and protect legitimate lenders and their clients.

The 2008 foreclosure crisis and the aforementioned fraudulent mortgages have led FHA and the rest of the federal government to take steps to reform the system, share management over the loans with lenders and assist borrowers in order to prevent them from joining the foreclosure list. Among the initiatives the government undertook were programs designed to expand eligibility for consumers, reduce the size of payments and entice more lenders to participate in FHA mortgage programs (Meisner & Thomas, 2009). By enabling more loans to be made, the FHA might better use them to increase the financial safety net to offset the present and future housing crises.

Thus far, this paper has analyzed two major and widely used forms of mortgage products. In addition to government-backed and conventional FRMs and ARMs, however, there is another type of mortgage product that offers a new innovative set of benefits and risks for homebuyers and homeowners alike.

'Outside-the Box' Mortgage Products

Most mortgage products are standard, 15- and 30- year plans in which interest rates are either fixed at the time of the loan or adjustable based on changes in the economy. Some are uninsured, using a sizable down payment as leverage, and some are backed by the federal government (allowing for less of a down payment). There are other mortgage products that operate in a different manner than standard mortgages. They are relatively new and innovative, which offer great benefits but also pose great risks to the borrower as well as the lender.

Reverse Mortgages

One such loan is known as the "reverse mortgage." This product stems from two major trends. First, seniors are living longer than ever and, as a result, they need more money to help them through their retirement years. Second, the average value of a home has skyrocketed over the last several decades, which means that seniors who have lived in the same house for long periods of time have built up a significant amount of equity. Although the concept of the reverse mortgage has been in existence for nearly a quarter of a century, in recent years, in light of the rising cost of living for seniors, more and more people are taking advantage of them.

A reverse mortgage entails borrowing part of the equity a homeowner has in his or her property. However, interest and principal on the loan are not paid until after the individual dies or moves out of the house. Over time, the equity diminishes as the loan increases. The benefit of such a product is that the homeowner cannot be foreclosed upon unless the homeowner lets the house fall into disrepair or fails to pay taxes ("Reverse mortgages," 2008). However, there are risks — because of the enticements of borrowing without paying for the loans until after moving, seniors are increasingly becoming the targets of aggressive lenders who may apply hidden fees, make misleading statements and otherwise push the program on the borrower. Recently, several key government officials have called for greater oversight of these innovative but risky programs (Hopkins, 2009).

Interest-only Loans

Another atypical mortgage product is geared toward people whose incomes are largely bonus-, commission- or investment-based. Interest-only mortgages allow the borrower to pay only on the mortgage's interest for a fixed term (often five to seven years). After that period, the borrower may refinance, pay the balance on the mortgage or begin paying off the principal. Financial advisors point out that such mortgages are geared toward people whose income is limited to such periodic payments rather than consistent salaries (Lewis, 2009). In an ever-diversifying international economy, such target-specific mortgages continue to be introduced, giving perceived relief to homebuyers while forcing financial insurers and government backers to play a game of catch-up to ensure that lenders and borrowers are protected.

Conclusions

The 19th century writer and philosopher, Harriet Martineau, once said, "There are few things in my life which have had a more genial effect on my mind than the possession of a piece of land" (WorldofQuotes.com, 2009). Indeed, for most people, the dream of a home of their own is a dream well worth pursuing.

Of course, home ownership has become more expensive since the days of the 19th century American westward expansion. Still, financial institutions and other lenders have provided a wide range of services to help people achieve their goals. These mortgage products are suited to meet the needs of people of nearly every economic stratum.

For those who can afford to put a larger portion of their income into a down payment, conventional mortgages bring about greater levels of equity immediately upon closing. Those whose monetary capabilities are more limited may pursue government-backed FHA loans. Lenders even offer a number of innovative, albeit more risky, alternatives to traditional mortgages to meet the needs of those with specialized or retirement incomes.

The federal government has taken great strides to combat fraud in and enhance the attractiveness of the ever-expanding field of diverse mortgage products, particularly during times of economic instability when housing markets suffer. This careful oversight is critical, for in light of an ever-evolving 20th and 21st century economic system, mortgage products will likely continue to evolve as well.

Terms & Concepts

Adjustable Rate Mortgage: Loan in which the interest rate varies with shifts in the national rate.

Conventional Mortgage: Privately administered mortgage that meets the guidelines of Freddie Mac and Fannie Mae.

Fixed-Rate Mortgage: Loan in which the interest rate is locked in at the time of closing.

Fannie Mae: Federal National Mortgage Association, a federally-sponsored agency that provides backing for mortgage lenders.

Freddie Mac: Federal Home Loan Mortgage Corporation, a government-sponsored institution that expands and supports mortgage lending practices.

Interest Only Mortgage: Short-term loan in which borrower pays monthly installments to pay off only the interest on a home mortgage.

Reverse Mortgage: Mortgage in which the consumer borrows against the equity of his or her property without repaying interest or principal until he or she moves or dies.

Bibliography

Ahmed, I., Ashfaq, S., Mahmood, S., & Farooq, U. (2012). Determinant attributes of customer choice of banks, supplying mortgage products. Journal of Economics & Behavioral Studies, 4, 287-296. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89039913&site=ehost-live

Cocco, J.F. (2013). Evidence on the benefits of alternative mortgage products. Journal of Finance, 68, 1663-1690. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89079583&site=ehost-live

Economic ups and downs. (2009, June 17). USA Today. 8A.

FHA Research Center. (2009). FHA mortgages. Retrieved June 25, 2009 from http://www.fharesearchcenter.com.

FHA 'zero pay' defaults rising. (2009). National Mortgage News, 33, 1-8. Retrieved June 26, 2009 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=37216929&site=ehost-live

Hopkins, C. (2009). Dugan: Reverse mortgages risky. American Banker, 174, 16. Retrieved June 26, 2009 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=41330155&site=ehost-live

Kerr, T. (2009, May 4). Which mortgage for you? FHA loan or conventional mortgage? Retrieved June 25, 2009 from MortgageLoan.com. http://www.mortgageloan.com/which-mortgage-for-you-fha-loan-or -conventional-mortgage-3077.

Lewis, H. (2009). Who should get an interest-only mortgage? Retrieved June 26, 2009 from Bankrate.com. http://www.bankrate.com/brm/news/mtg/20020620b.asp.

Marples, G. (2008, September 11). The history of home mortgages — a "dead pledge." Retrieved June 24, 2009 from thehistoryof.net http://www.thehistoryof.net/history-of-home-mortgages.html.

Reverse mortgages: How they work. (2008, April). Retirement Planning. Retrieved June 26, 2009 from ConsumerReports.org. http://www.consumerreports.org/cro/money/retirement-planning/reverse -mortgages-4-08/how-they-work/reverse-mortgages-how-they-work.htm.

Sheedy, R.L. (2013). Tighter rules on reverse mortgages. Kiplinger's Retirement Report, 20, 8-9. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=91643363&site=ehost-live

Sinnock, B. (2009, May 25). Borrowers hate ARMs. National Mortgage News, 33, 14. Retrieved June 25, 2009 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=41140762&site=ehost-live

Turner, F. J. (1893). The Significance of the Frontier in American History [Excerpt]. Retrieved June 24, 2009 from Skagit River Journal http://www.stumpranchonline.com/skagitjournal/Washington/Gen/Homesteadin ng01.html.

http://www.worldofquotes.com/topic/Land/index.html. Accessed June 26, 2009.

Suggested Reading

Armour, S. (2009, June 5). Mortgage crisis robbing seniors of gold years. USA Today.

Canavan, K. (2009, June 12). Educate yourself to cut closing costs. USA Today.

Finkelstein, B. (2009, February 2). Seniors can buy homes using FHA reverse mortgages. National Mortgage News, 33, 10. Retrieved June 26, 2009 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=36456331&site=ehost-live

Harmon, J. (2009, March). ARM borrowers seek rescue from FHA program. Mortgage Servicing News, 13, 24. Retrieved June 26, 2009 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=37286275&site=ehost-live

What can the FHA do? (2008, August 15). Mortgage Line. Retrieved June 26, 2009 from EBSCO Online Database Regional Business News.