American Mortgage: Part 1
04.01.22
In a culture where 56% of Americans have canceled plans to browse house listings on Zillow (according to Southern Living), the cult of American homeownership is very much alive today.
Millennials — perhaps the generational cohort least likely to qualify for homeownership — admit to uncontrollable Zillow binges, scrolling the site at all hours of the day. “There’s a deep pleasure in visiting a home valued around $8 million and tutting, ‘There’s just not enough natural light in the master suite,’” confessed one Zillow scroller. “I look at open plans in horror,” said another. “Why do you want to gaze at the back of your couch while doing dishes? Why do they use that loud distracting marble in all of the bathrooms? Why is everything painted gray?”
Some mystified observers have taken the route of addiction management. “Identify your triggers,” advises The New Yorker. “Where are you when it dawns on you that could probably afford a spacious full-floor apartment in Iowa City for the same amount you pay to rent a cramped studio apartment in Bed-Stuy with a heater that’s ‘just for display’?” Others hope to monetize the 201 million unique monthly users, feeding the frenzy with lurid social media accounts such as @zillowgonewild and @seth.hollingsworth’s personal account, which achieved viral fame thanks to his #scaryzillow TikTok tours.
Sadly, for many Millennials, the fantasy of homeownership may remain as ephemeral as a TikTok reel. The Great Recession cast a long shadow over youth homeownership: by 2040, younger millennials are projected to have a homeownership rate 8 percentage points lower than younger boomers at the same age (64% vs. 72%), and over a third of households will be headed by senior citizens. “Unfortunately, the middle-class dream of homeownership has been fading away,” says chief economist Daryl Fairweather of Redfin, a prominent real estate brokerage. Owning a home, she added, “is a signifier of the upper class now.”
How dire is the American housing situation? Will most younger generations be relegated to stalking the living rooms of their richer elders on Zillow or eking out sweat equity in a quasi-commune McMansion? Is single-family mass homeownership even still desirable in an increasingly urban future?
In our first article on homeownership — the largest credit decision most Americans will make in their lifetime — we discuss the evolution of American mortgages, a century-long federal experiment in mass lending and underwriting risk. We learn that mortgage credit has never been dispensed equally, oscillating between freewheeling, loose periods of credit (or, as one reader said, “Everybody gets a financial trophy — 2008 all over again”), and stricter, more regulated periods that doled out special protections to select groups of Americans while severely limiting credit access for others.
Birth of the Modern Mortgage
“No man who owns his own house and lot can be a communist. He has too much to do,”
— William Levitt, father of modern suburbia
Early American mortgage terms would send most Millennial buyers quaking in their Allbirds. Until the 1930s, mortgage loans were characterized by astronomical down payments (50–60%), low loan-to-value ratios, nonamortizable balloon payments, and variable interest rates. The period was marked by “a substantially lower homeownership rate than today,” according to mortgage credit scholars, with just 48% of American households owning their home in 1890 as compared to 65.6% in Q1 2021.
Most Americans were highly suspicious of credit and long-term lending horizons. One Senator, when confronted with the specter of a thirty-year fixed-rate mortgage in 1933, remarked: “I am still old-fashioned enough to believe in thrift… And you do not encourage it by inviting a man to go in a house and give him 30 or 40 years to pay for it.”
As a result, first-time homebuyers often had to resort to two or even three mortgages to manage the down payment. In 1903, half of all mortgage loans were made by individuals and the other half were made by small-time institutional lenders — usually a local insurance company or savings institution. Housing was not financialized in that lenders kept the loans on their own books for the duration of the loan. “Mortgages were intensely local affairs between individuals who lived in the same geographic area,” writes University of Iowa law professor Christopher Odinet. “There was no national market of which to speak. Credit was local and stayed local.”
The short-term funding structure of most mortgages proved untenable during the Great Depression. “Banks began calling back the full value of the loans rather than allowing borrowers to refinance, which meant that even borrowers who could have afforded the monthly loan costs were blindsided by having to repay the full value of the mortgage,” writes political scientist Chloe Thurston in her recent investigation of federal mortgage policy, At the Boundaries of Homeownership: Credit, Discrimination, and the American State.
By January of 1934, almost half of all urban, mortgaged owner-occupied dwellings were in default. Thirty-nine out of every thousand mortgaged farms were also in foreclosure. The combination of a “banking crisis, a credit crisis, a foreclosure crisis, and an unemployment crisis” led federal officials to embark on a radical new experiment in mortgage finance. Congress unleashed a series of new agencies to fundamentally alter both the structure and the source of mortgage loans.
“Mongrel institutions” that were neither public nor private came to dominate the housing market. Chief among them was the Federal Housing Administration, which insured private mortgage lenders against default risk, and Fannie Mae, which created a secondary market for mortgage loans.
Federal policies gutted the short-term, equity heavy mortgages of yesteryear, replacing them with low-down-payments and long-term repayment schedules that helped make homeownership more affordable to millions of households. Interest rates were capped at 5% (previously, they were as high as 10%) and the Federal Housing Association promised to insure loans of up to 80% LTV (this later increased to 97%). Interest rates were fixed and loans were fully amortized, removing uncertainty and surprise payments for the borrower. “It made buying a house comparable to renting — at least in terms of the monthly costs,” said Thurston.
Standardization Leads to Discriminatory Lending
As down payments were relaxed, the borrower’s personal characteristics assumed an outsized position in risk assessment. Previously, lenders had relied on fat down payments to insulate them from losses, a luxury that was no longer possible with a mere 20% deposit. Instead, lenders and government underwriters fixated on personal traits that might affect the long-term value of the property or impact the borrower’s future ability to pay. This shift had long-term deleterious effects for minorities and women seeking credit.
In 1936, the FHA released a 260-plus-page Underwriting Manual, which provided the first uniform guidelines for determining insurable risk. Early editions of the manual explicitly endorsed segregationist policies, urging federal underwriters to consider the presence of “inharmonious racial groups” and protect “against infiltration” by racial and ethnic minorities including blacks, some Italians, and Jews. Such groups were considered a long-term risk to neighborhood house values, beginning the long and shameful tradition of redlining entire urban neighborhoods, in which “no mortgage would be accepted for insurance in any block in th[at] area.”
In one World War II development, the “FHA would not go ahead with [a] development unless the developer built a 6-foot-high wall, cement wall, separating his development from a nearby African-American neighborhood to make sure that no African-Americans could even walk into that neighborhood.” The government, concluded Rachel Heiman, associate professor of anthropology at the New School, “Helped people, but only white people, to get into the suburbs.” While race restrictive covenants were finally banned in a 1948 Supreme Court decision, many lenders continued to exclude blacks from the mainstream mortgage market, forcing them to pay two or three times the amount to “panic peddlers.”
Women were also perceived as a unique credit risk given their (often) temporary roles within the workplace and the possibility of pregnancy. Women’s credit histories were erased upon marriage (credit cards had to be reissued to their husbands) and creditors were often unwilling to count a woman’s income towards mortgage payments.
Lenders only relaxed this rule if provided with a “baby letter” (a term popularized by the banking industry) that guaranteed minimal risk of pregnancy and was usually signed by a medical professional testifying that the woman was on birth control, had undergone a hysterectomy, or would terminate the pregnancy. One woman, who wanted to use documentation of her husband’s vasectomy in its stead, was denied by the loan officer, who told her, “You could still get pregnant.”
The National Organization of Women spearheaded the feminist credit movement of the 1970s and explicitly addressed “the morbid preoccupation of creditors with pregnancy,” urging that such practices were dreadfully outmoded and made poor business sense. “In the cases where both incomes are necessary to maintain mortgage payments, if the couple still decides that the wife should terminate her income-producing employment, it is more likely that the couple would sell their home than leave themselves in a position of having insufficient funds to make the mortgage payments.” It added: “We have yet to hear of a foreclosure caused by a pregnancy.”
The Ascendancy of FICO
Despite its early discriminatory credit policies, the federal government remains the primary driver behind Americans’ single-minded pursuit of homeownership. Thanks to a century of federal policy decisions, homeownership remains Americans’ dominant option (and chief aspiration) for housing today.
In our next article on American mortgages, we will discuss how the community reinvestment movement and the feminist credit movement of the 1970s led to the ascendancy of FICO scores in credit decisions, how alternative data is finally beginning to challenge that ascendancy, and how a growing coalition of interest groups seeks to dismantle the binary outcomes of the housing market: buying or renting.
“Homeownership isn’t going anywhere,” concludes Shane Randall, author of The Affordable City: Strategies for Putting Housing Within Reach. “Ending it shouldn’t be America’s goal… but mass homeownership shouldn’t be our societal objective, either — it fails too many people and perpetuates too many historical inequities to remain the sole symbol of success in the housing market.” He adds: “We deserve better than the two flawed choices available to us: unstable and unprosperous renting or risky, inaccessible, and inequitable private ownership.”
About Colbeck: Colbeck is a strategic lender that partners with companies during periods of transition, providing creative capital solutions to meet their evolving needs. You can reach the team at inquiries@colbeck.com.
