The rest of the world has a different opinion on the quality of life enjoyed by middle class citizens of the United States. This was brought home to me recently when an acquaintance from Great Britain visited the United States of America, specifically suburban Raleigh Durham, for their first time. In driving around and looking out all the houses all she could say again and again was “Is everybody in America rich?” I guess if you’re from a country with smalish housing designed for a significantly greater population density as compared to the US average, then even the middle class homes with sizes ranging at a bit under a thousand square feet to four thousand sq. foot McMansions in some suburban neighborhoods would seem ostentatious. Part of the disparity is because of the age-old advantage of the space available in the United States that allows for greater numbers of large homes. So space allows for size, but the sheer volume of homes is simply because we are in debt up the wazoo. We have a system of subsidized thirty year mortgages that are underwritten by the federal government via insurance programs and tax incentives. This is the norm for America, but not the rest of the world which has a broad range of home loan options. Only in a very few cases are the rest of the world’s mortgage options the same length or longer than the United States.
I’m not lambasting our entire system. There are pro’s to be sure. The biggest of which is the equity growth over time. Even taking into consideration the housing meltdown, having a home mortgage is mostly a surefire way of building wealth. Another pro, as I’ve outlined earlier, is the actual size of the housing. Let’s face it everybody likes more space. The impact of these benefits and enablement policies means that the culture around mortgages has changed. The idea of not having a mortgage is so alien, that it’s incomprehensible to most people. Having a regular monthly bill that absorbs 1/3rd of your gross income for the majority of your working life is bad. Having that same monthly bill in an era of growing transition to irregular income streams for the majority of the population is really bad. When you consider that nearly 80 percent of the US population doesn’t keep a significant buffer of savings and lives ‘paycheck to paycheck’ then housing becomes a big problem. With all Big Problems, Big Solutions articles we start with the question: How did we get here?
History:
Like so many other things in life, the thirty year mortgage got its start in the great depression a part of the New Deal. In the 1920’s mortgages where much like the way the rest of the world operates them today. Balloon loans with 3-5 year terms were the norm. There was a general expectation that borrowers would be able to refinance at the prevailing interest rate when the balloon came due. After the crash of 1929 the government took action via the Home Owners’ Loan Corporation, a government-sponsored enterprise to keep the mortgage system liquid when the financial systems froze after the crash. Shorter term liquidity did not create a departure from, as Time Magazine put it, an “old-fashioned mortgage that was renewed in good times and foreclosed in bad.” It was in 1934 that the Federal Housing Administration came up with a new privately funded but government organized plan built around extended payback periods, periods measured in decades. This made the mortgages independent of short-term fluctuations in the larger economy. What bankers thought of initially as immorally long terms, 15-30 year home notes became the standard. This meant that mortgages would end when people would start to retire from the workforce and collect their pensions allowing for seniors to not have a home payment when their incomes dropped. It can be argued that this was one of the greatest financial innovations of all time, but this innovation matched the economy of the era, not the modern one.
Long term mortgages
What’s the end result? If you really step back and assess the situation, it’s not all peaches and cream when it comes to mortgages. It’s actually kind of a mixed bag. We have a housing market that ebbs and flows on the 30 year mortgage that is based on the prime rate issued by the US Government. The ups and downs of the housing market affect the economy as a whole.
As I stated before, the culture has changed. Buying a home is a right of passage. This is reinforced because having a mortgage is considered a positive thing by many financial planners due in large part to the tax benefits. This is especially true if your a high wage earner who has little in the way of tax breaks. It’s aspirational even to people whose life is so dysfunctional they could never make regular payments for thirty years. This of course was the underpinnings of the housing market crash of a few years ago. Too many people who couldn’t pay back their loans had gotten mortgages, and those mortgages were securitized and sold as an ultra high quality stable investment which they were not. When investors who funded the mortgage system got skittish, they stopped buying the securities which means no more money was flowing into the housing market. It was pretty much a repeat of the housing market situation after the stock market crash of 1929.
I would argue that there are substantial lessons from the stock market crash and mortgage crisis in the early part of the 20th century in the same way there was after the ‘29 market crash. The primary lesson in ‘29 is that large purchases paid for over the long term should be divorced from the ebb and flow of the economy. The generally accepted lesson learned from the early 2000’s is that not everyone should own a home, but that’s wrong. The real lesson is that not everyone should have a mortgage. As I said, when push comes to shove the mortgage solution at the time was truly brilliant for the challenges the country was facing as well as the structure of the American Workforce. I also like the thinking of FDR, the idea that debt service is somewhat related to immorality. But this line of thinking does lead to a conundrum. What is worse from a moral perspective? The immorality of high rates of foreclosures or an immorality of a lifetime in debt for the majority of a population?
This brings us to the genesis of our Big Solution: Where home ownership is concerned, the ultimate goal should be ownership without a debt service as quickly as possible. This is great for all parties, except maybe the bankers. So how do we get to this end? How do we get to the big solution of getting as many people into home ownership as possible without a lifetime of debt service? What are the options?
We could disconnect the mortgage market from the government. This would put us back to a profit oriented model where banks issue mostly adjustable rate mortgages with balloons like they did before the great depression. This model is more common in the rest of the world and works ok when the market is liquid. People just expect that they will have new mortgage payments every five years or so when their balloon comes due. They understand that these new payments will be in line with market rates. Banks want much quicker payback terms so the average mortgage would be 5-15 years with the aforementioned balloon payment towards the end that needs to be refinanced. Ultimately, in addition to returning to greater numbers of foreclosures in bad times, I think this system will be like our current one, i.e. we are in debt forever. The bank’s job is to extract as much interest out of their customers as possible. They really aren’t interested in expediting the payoff of the home. There would always be incentives to keep refinancing or going to ever higher mortgages attached to more expensive properties.
Option two would be to just tweak the existing system. You could lower the length of the fixed rate mortgages. You could reduce or eliminate the interest deduction which would lower home prices, encourage smaller homes and incentivize more people to rent. All of these options will have a strongly negative effect on current home prices and bring on the threat of severe economic disruption. Fortunately the economic upheaval would only be temporary until the system gets used to the new normal. This would be the type of simplistic solution that would be adopted if anyone had the political will to try and get a population away from spending the majority of their life with a debt service. Considering the culture of debt this nation fosters, and considering how highly valued the mortgage interest deduction is to the population at large I cannot imagine a politician who could champion this type of change even if it would be better for the long-term.
So what is the out of the box solution? Let’s look at the fundamental concepts for a solution. We know that the following is true: Equity growth is good. This means whatever system we choose should include some form of wealth generation for the individual. This also means we don’t throw out owning a home altogether. Owning a home is mostly good, it’s a great way to build wealth and to meet a basic human need of housing. Additionally we know that housing transactions are more difficult when ownership is involved. Lose your job and you don’t just move out at the end of a lease, you have to go through a property sale or foreclosure. The biggest fundamental truth, one that I’m sure I am mostly alone in believing, is that debt, in general, is bad. Debt limits options in life. It’s that simple. Less debt generally equals more money. The newest fundamental truth is that in the information age traditional jobs kept for life is a ghost of the past. I can’t say it enough. Long term debt with consistent service requirements in an age of inconsistent employment and commensurate inconsistent income is very very bad.
So how do you have people own a home but not take on the burden of a mortgage? How do you have them get enough housing for their unique needs at any particular point in life? I have come to the conclusion that it’s mostly a paper solution, ie it’s about how the money is handled. Practically speaking there needs to be a monthly payment of some sort because housing is very expensive. We can’t just say all property transactions must be a cash sale because the vast majority of people don’t have the self discipline to save for years or decades unless they are forced too.
The big solution I envision is some sort of formalized national rent to own. I’m not talking about a system like this sleazy rent to own furniture places who have built entire corporate business models around screwing the poor. I’m talking about a system where you rent when you start and while you rent your building savings for your home purchase. An example of how this could be accomplished is rental regulations which would require a minimum of 25% of rent going into a conservative investment account, assuming the renter isn’t a homeowner. Obviously the amount doesn’t have to be 25%, You could set up different programs to get people into ownership quicker, i.e. you could incentivize 33% or 50% of the rent to go into the home ownership account. You could also set it up for longer terms for those that think they may never want to own, say 5% or 10%. If the renter chooses to never become a homeowner, the revenue ultimately could eventually go into their retirement income. If the renter chooses to purchase, then when they have enough cash built up they can buy what they want. It’s like a 401K but for housing. The target should be ownership in a very short period of time, say under a decade. When the renter decides to use the money they saved to eventually purchase, the home should have no mortgage or if we still allow them, then it should have to meet the same stringent requirements / valuations to get the home mortgage of today with term limits to 5 or 10 years until the home is paid in full. Afterwords if the homeowner wants or needs to grow the size of their home they enter into a homeowner savings agreement where regular investment payments continue until it’s time for the ownership cycle to repeat itself.
The benefits of this system is that the transaction is easier. If your just renting you can move quite often based upon your income levels. Your speed in getting to the first tier in housing is based upon your income. If your income goes up, then your rental gets more affluent and a greater amount of cash goes into the house fund. If Income goes down, rental size naturally goes down yet you are still saving but it’s a smaller amount of cash into house fund. This will really help with people who have ups and downs in their household income.
In addition to the benefit of fiscal stability, this type of system may have a significant cultural impact. For example if a family is not stuck to servicing a thirty year mortgage it could allow that couple to have a stay at home parent more easily. If still in the rental stage then all they have to do is move to a less expensive rental at the end of a lease period. Savings for the eventual house purchase is still happening but at a slower rate. As soon as the stay-at-home parent wants to go back to work they could simply move to a bigger place that automatically puts more money into the home purchase account. Our housing culture already comprehends the concept of a starter home. Once the financial institutions that are handling the rental savings facilitate the transaction to the home purchase, they can also facilitate the additional savings program to help the family or home owner move up in home. Then system continues as a payment as part of the smaller mortgage or property tax bill. The key is that with this big solution the majority of the cash is equity growth in front of the purchase not interest service from behind. Mathematically if the homeowner has a 100K house and pay an extra $400/month into escrow on top of taxes, then in five years the homeowner moves into a $150,000 house.
This big solution meets the needs for immediate housing via rentals, meets the needs for flexible housing if income goes up, down, or stagnates and most importantly it eliminates 30 year mortgage commitments. By default I think housing sizes will shrink to be more in line with the rest of the world. This can be seen as a negative or a positive. The negative of reduced size is less space, but on the positive side smaller homes equals less stuff. Less stuff usually equals less stress.
One more point on this Big Solution. We have a hugely varied workforce. There still are professionals who maintain positions that have tenures at single institutions measured in whole careers or in decades. These folks obviously are the extreme minority and are shrinking every year. They can still be serviced by the existing system but would have to qualify to get the traditional mortgage. We could then focus the new system on everyone else. This national rent to own program may also be a good solution for low income families in that it forces them to build equity over time and eventual home ownership bypassing the risk of the mortgage. I have seen analogous systems that already exist with state and local low income housing programs, although they are not focused on 100% ownership. Typically they are programs designed for helping lower income families save for the ‘down payment’ and then those folks get saddled with a thirty year mortgage, which is precisely what we are trying to avoid with this solution.
Our housing system is a tough nut to crack. With a concerted effort it may take a couple of decades to get this type of alternative solution accepted into the public discourse and into it’s initial adoption phases. Ironically that’s still about ten years less than the average mortgage.
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-Mike.
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