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What Happened, and How Did We Get Here?
TO THE CONSUMER, it may seem like a mortgage is a mortgage is a mortgage. Find a house, put some money down, and move in. But the mortgage industry has gone through some major changes that affect absolutely everyone who wants to obtain financing to buy a home. Everyone.
Understanding and interpreting these changes is critical to properly planning for the right financing. Make a mistake, and you’ll get the wrong loan. A mistake on a 30-year mortgage means a potential reminder of that mistake for the next 360 months. It can even mean the difference between getting approved or not getting approved.
What used to be a complex mess of literally hundreds of different loan types has now been broken down into two basic categories: conventional and government. But those loans have also taken on their own twists and turns like never before.
For a 30-year fixed-rate loan, there are now literally 54 permutations to calculate not only the rate and terms but the literal approval itself. Loan programs have vanished. Credit guidelines have been restored to their original roots and in some cases made more onerous. Still others provide financing options not available before. It used to be that simply applying for a mortgage loan meant an approval of some type, somewhere. No longer. It also used to mean that almost anyone could be in the mortgage business and become a ‘‘loan officer.’’ No longer.
This is the first book that lays out the new rules, why they’re there and how to get approved in the new mortgage market. Or perhaps ‘‘new’’ isn’t the best descriptor. Perhaps it’s simply a reversion to original lending guidelines. In reality, both statements are correct. But to understand where we are now, we have to understand how we got here.
A LITTLE HISTORY
Early in the twentieth century, mortgages were made the old-fashioned way. When someone wanted to buy a home, the bank would have a meeting and decide whether to make a loan. If it decided its customer was deemed worthy of a home loan, it would go to the vault, or most likely write a check, on behalf of the borrower paid to the seller of
the real estate. Needless to say, many people were kept out of home ownership in the metropolitan areas.
Even if you could get a mortgage, the terms made it such that only the rich people could get a home loan, as the down payment could be as high as 50 percent or more. One would think that if the down payment were 50 percent, then why even bother with getting a loan—why not keep saving for the down payment until there was enough money to write a check for the entire amount?
The loan would go to a loan committee and the participants would review things such as the customer’s income and profession. They would review the customer’s history with the bank to make sure the applicant had paid all previous loans on time. If the bank felt good about the loan, voila, new homeowner.
As the country began to sink into the throes of the Great Depression in the late 1920s, pretty much everything financial came to an abrupt halt. The stock market crashed, home values declined, and people were laid off from their jobs.
Among other things, it took the government to help an economy mired in economic distress and fear. (Does anything sounding remotely familiar here?)
In 1934, the Federal Housing Administration was created under the auspices of the Department of Housing and Urban Development, and FHA loans were created. Actually, FHA loans aren’t loans but are just called that. FHA instead insures mortgage loans. If a bank made a loan that conformed to FHA guidelines and the loan went into default, the lender would get its money back.
This loosened the purse strings of the bankers, and soon mortgage loans became a bit more commoditized with the introduction of FHA-insured mortgage loans. The plan worked, and more loans were being made to more people with less money down. However, banks need to have money to loan money. If they ran out of money, they would have to advertise and raise more money through offering interest on people’s deposits. If, for instance, they offered a savings account paying 2 percent, they could take enough money and charge someone getting a home loan 5 percent and make
3 percent off of the money. This is a bit simplistic, but at its core is exactly how it worked. Banks would lend the money they received from their depositors. It’s also why banks worked more with wealthier people, because it was those people who had the assets that needed to be protected. At least that was the theory.
In practice, banks sometimes ran out of money to lend. Thus, the Federal National Mortgage Association (FNMA), or Fannie Mae, was created in 1938 to foster home ownership. It also operated under the auspices of HUD.
Fannie’s job was to buy mortgage loans from banks that made FHA-insured mortgage loans when banks ran out of money to lend. This was the infancy of what is called the ‘‘secondary’’ market for mortgage loans, which we’ll discuss in detail later in the chapter.
The federal government provided Fannie Mae with money, and Fannie Mae began to establish guidelines for the types of loans it would buy. If a loan conformed to these newly issued guidelines, Fannie would buy the loan from the issuing bank if the bank wanted to sell the loan and free up its capital to make more loans.
In 1944 as part of the GI Bill, zero-down mortgage loans were available for returning war veterans, and the pace of home buying began to pick up; the effects of the Great Depression were long since gone.
During this very brief period from 1934 to 1944, the mortgage industry began to show its force in the economy. When people bought their own homes, they also bought all the other stuff that went with home ownership, like furniture, appliances, and general maintenance on the home.
As more and more veterans returned from the war, lenders were making more loans than ever—both VA loans as well as FHA-insured ones. Banks began to lend like never before, and a housing boom went right along with the Baby Boom.
Things worked this way throughout the 1950s and 1960s. In 1968, Fannie broke away from HUD, and a couple of years later, the Federal Home Loan Mortgage Corporation (FHLMC), or Freddie Mac, was formed. In 1968, Fannie’s charter changed to become a government-sponsored entity, or GSE.
Fannie was a private company that issued its own stock but was sponsored by the federal government. Although it wasn’t exactly a business owned by the government, it was close to it. Freddie’s chartering in 1970 was set up the same as Fannie Mae. Both entities were supposed to foster home ownership by freeing up cash for lenders in the mortgage markets.
But at the same time, both had stockholders they had to please. Fannie and Freddie both had an obligation from the federal government to provide liquidity in the mortgage marketplace, while at the very same time had to satisfy their shareholders to make a profit. The GSE was an interesting experiment, crossing government and private enterprise with two separate goals.
Things went smoothly for much of the next 20 years. Then things began to change, slowly, for the worse.