The ability to own a home is part of the American dream. America’s capitalist drive makes us look for innovative ways to make things bigger and more expensive; perhaps the best example is the American mortgage market.
Hard to believe, but 100 years ago mortgages were not widely used. Today families can get a 30-year mortgage with down payments of 20 percent or less. These mortgages have convinced Americans to buy bigger homes with fancier amenities, but mortgages lock many families into 30-year contracts that make their home their primary saving tool.
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The mortgage has increased the value of homes and because home payments are stretched out over a 30-year period people feel they can afford more. The increased affordability of homes leads home sellers and realtors into increasing the price because credit is much easier to get. The dramatic increase in the costs of homes has raised all living costs, even the prices of rental units. This isn’t to say that homes aren’t a smart investment, but for many, it would be better to rent or start with a smaller home.
History of the Mortgage
Mortgages in the U.S. took hold in the 1930s to spur the purchase of homes in America. However, these mortgages didn’t look much like the modern mortgage. The 30s mortgages required that you put 50 percent down and pay off the mortgage in 3 to 5 years. Little changed over the next 40 years. The average cost of a home in the 1960s was just over $11,900 dollars and the average family income was $6,000. Adjusting for inflation to figure out what this would be today, a home would cost about $100,000 and the average yearly family income would be $50,000. Instead, the average home in America costs $370,000 today and the average American family income is $51,000.
Why have salaries stayed pretty much the same but the average cost of a home has almost quadrupled? A lot of it has to do with mortgages. In the 1970s and 1980s, mortgages started to change. The amount of money that families had to put down started to go down to 20% of the home or less, depending on the type of loan. Instead of needing to pay off the loan in 5 to 10 years, the 30-year mortgage was created. The government, at the behest of the banking and housing industry, came up with these new loan terms to incentivize the housing market and allow more Americans to buy a home. However, it also allowed the housing industry to start creating bigger and more expensive homes. Homes that would have been mansions just years before were now accessible to middle class families. These huge homes and long-term mortgages eventually got ultra-low interest rates thanks to secondary markets, where banks packaged and sold the mortgages to other banks. Over-speculation led this market to collapse in the late 2000s, causing the Great Recession.
An average American family making $51,000 trying to buy the average $370,000 American home using a 30-year mortgage with a 20 percent down payment, will end up paying nearly the cost of the home in interest over the life of the loan. Assuming a $70,000 down payment and the current 4.3 percent interest rates, over the 30-year mortgage the family will have paid $250,000 of interest. In fact, the $70,000 down payment is closer to what the cost of the home would be if not for banks and builders pushing (and consumers) for larger homes and 30-year mortgages. This calculation uses the record low interest rates of today. While 4.3 percent is higher than it has been over the last ten-years, it’s still much lower than the nearly 10 percent interest rate of the 70s, 80s, and 90s.
Rental costs in the United States have also seen similar increases over the past 40 years. This might seem to indicate that mortgages aren’t the direct cause, but the 30-year mortgage may be partially responsible for this increase as well. As homes became drastically more expensive, fewer people (who have working class jobs, high student loans, or childcare costs) are able to afford to purchase a home increasing the demand for rental units. With more people looking to rent, apartment owners have been able to increase their costs. Adjusted for inflation, family incomes have stayed mostly flat over the last 50 years, but the average monthly rent across the country has nearly tripled from $250 a month to nearly $650 a month today, adjusted for inflation.
Homes as an Investment
If there is any personal advice, it’s to try to limit your exposure to a huge mortgage that will keep you from being able to put your money to work in other ways. A home has historically been a great way to build family wealth, but this is also partially because the 30-year mortgage increased the value of homes. Looking forward it’s hard to tell if homes will be a good long-term investment for current generations compared to their parents. The best thing to do is to not buy more home than you need. If you’re planning on staying in a place for 3 to 5 years, buying can be a good idea. Just make sure that you’re not putting all your savings into a huge mortgage. Renting and putting your savings into investments is also a good way to build your wealth faster. Homes haven’t increased in value much more than 5–7 percent per year. If you are paying yearly interest on the loan of 4 percent, you are only gaining 1–3 percent in return on your home every year. It may be smarter to rent and put more of your income into investments.