Abolish the 30-year fixed-rate mortgage!

October 21, 2011
File under "Republican ideas which are actually rather good":

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File under “Republican ideas which are actually rather good”:

Congressional Democrats remain strongly committed to the 30-year fixed-rate loan, which protects homeowners against a rise in interest rates. But some Republicans, who want to scale back the government’s role in the housing market, have growing doubts about the taxpayer-subsidized loan product.

During a Senate Banking Committee hearing Thursday, the panel’s top Republican, Sen. Richard Shelby, asked a series of questions that critics of the 30-year fixed-rate mortgage have long been focused on.

“What unintended consequences have been created by subsidizing the 30-year fixed-rate mortgage? And what has the subsidy of this product already cost the American taxpayer?” Shelby asked. “We need to take a hard look at this product and determine if the preferential pricing resulting from these subsidies truly creates a public good.” …

Shelby asked another witness, the economist Paul Willen of the Federal Reserve Bank of Boston, to explain why fixed-rate mortgages can be more harmful to borrowers than adjustable-rate mortgages.

“So people who had fixed-rate mortgages from 2005 and 2006 and 2007, most of them are paying 5.5% or more on those mortgages. These are the people with negative equity,” Willen responded. “The people who had adjustable rate mortgages, their rates are under 4.5, and a third of them are paying less than 3.5% on their mortgages. They do that without any assistance whatever from anyone. They don’t have to beg their lender, they don’t have to get a modification,” Willen said.

That’s just one reason why the 30-year fixed-rate mortgage is a bad idea, and it’s not even the strongest one. The real reason this product should be abolished is that it simply doesn’t exist in any free-market system. In order to create it, you need to invent Fannie Mae and Freddie Mac — and just about everybody agrees that those two entities, which have cost the government hundreds of billions of dollars of late, and will probably cost even more going forwards, need to be radically downsized.

The simple truth is that without Frannie, you can’t have 30-year fixed-rate mortgages. Banks would never offer such creatures, and if they did, the interest rate on them would be so high, relative to adjustable-rate loans, that nobody would ever take them out.

A lot of the debate here seems, sadly, to surround the idea that such mortgages should be prepayable. Maybe if there was a prepayment penalty, they’d make more financial sense. But I’m not a fan of prepayment penalties at all — people should always have the ability to repay their loans just by paying back the full amount they owe.

At heart, it comes down to this: the 30-year fixed-rate product is always going to shift a huge amount of interest-rate risk onto the government in one form or another. Even the product’s defenders, like Susan Woodward, understand that:

“The critics of the 30-year fixed rate loan argue that this is unfair for households to get the benefits of reduce risk of fixed-rate loans while the taxpayers bear the risk,” she said in her written testimony. “This criticism forgets that homeowners are taxpayers too.”

No, it doesn’t. It’s true that homeowners are taxpayers. But it’s also true that renters are taxpayers. And homeowners already get far more than their fair share of tax relief, not least through the dreadful mortgage-interest tax deduction. We shouldn’t subsidize them even further by offering them financial products which would never normally exist in the wild.


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