A Brief History of Modern Mortgages | Finance and Commerce

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Michael J. Highfield, Mississippi State University

The average new US 30-year fixed-rate mortgage rate will top 7% in late October 2022 for the first time in over 20 years. This is up sharply from a year ago when lenders were charging homebuyers just 3.09% for the same type of loan.

Several factors affect mortgage interest rates, including the rate of inflation and the general economic outlook. A key driver of the ongoing upward spiral is a series of rate hikes by the Federal Reserve aimed at curbing inflation. The company’s decision to raise the benchmark interest rate by 0.75 percentage points to a maximum of 4% on November 2, 2022 will make mortgage borrowing costs even higher.

Even if you’ve had mortgage debt for years, you may not be familiar with the history of these loans. This is the subject of the undergraduate mortgage financing course at Mississippi State University.

The term dates back to medieval England. But the roots of these legal contracts go back thousands of years.

ancient roots

Historians trace the origins of mortgage contracts to the reign of Persian King Artaxerxes, who ruled modern-day Iran in the fifth century BC.

Derived from the Latin word for bank, mensa, mensari often used forums and temples as bases for their activities, taking out loans and charging interest to borrowers. These government-appointed public bankers required borrowers to provide collateral, whether real or personal, and their agreements on the use of collateral were dealt with in one of three ways. rice field.

First, Fiducia, Latin for “trust” or “confidence,” required the lender to surrender both title and title until the debt was paid in full. Ironically, the arrangement did not involve trust at all.

Second, pygnas, Latin for “pawn,” allowed the borrower to retain property while sacrificing possession and use until the debt was repaid.

Finally, Hypotheca, Latin for “pledge,” allows borrowers to retain both title and ownership while repaying their debts.

vow to live or die

Emperor Claudius brought Roman law and customs to England in 43 AD. During his subsequent four centuries of Roman rule and his subsequent six hundred years known as the Dark Ages, Britain adopted another Latin word, Vadium, to denote a pledge of security or loan security.

If offered as collateral for a loan, the property could be offered as “Vivum Vadium”. The literal translation of this term is “living pledge.” The land is temporarily pledged to the lender who used it to generate income to pay off the debt. Once the lender has collected enough income to cover the debt and some interest, the land is returned to the borrower.

Instead, in the “Mortuum Vadium” or “dead pledge” the land was pledged to the lender until the borrower could pay off the debt in full. It was essentially an interest-only loan that required full principal payment from the borrower at a future date. When the lender demanded repayment, the borrower had to repay the loan or lose the land.

The lender retains any income from the land, whether it comes from farming, selling timber, or renting residential properties. In effect, the land was dead to the debtor for the duration of the loan, as it provided no benefit to the borrower.

After William the Conqueror’s victory at the Battle of Hastings in 1066, English was heavily influenced by William’s language, Norman French.

This is how the Latin word “Mortuum Vadium” changed to “Mort Gage”, which means “dead” and “pledge” in Norman French. This mashup of his two words, “mortgage,” has since entered the English vocabulary.

Tenant Rights Establishment

Unlike today’s mortgages, which typically come to maturity within 15 or 30 years, 11th- to 16th-century English loans were unpredictable. Lenders can demand repayment at any time. If the borrower does not comply, the lender can seek a court order and the land will be forfeited from the borrower to the lender.

Unhappy borrowers could petition the king about their plight. He could entrust the case to the Chancellor, who could rule as he saw fit.

Sir Francis Bacon, Lord Chancellor of England from 1618 to 1621, established the Equity Act of Redemption.

This new right allowed borrowers to repay their debts even after default.

The formal end of the period for redeeming assets was called a foreclosure. It comes from an old French word meaning “to shut out.” Today, foreclosure is a legal process in which a lender takes possession of property used as collateral for a loan.

History of Early U.S. Housing

The current British colonization of the United States did not immediately transplant mortgages across the pond.

Eventually, however, U.S. financial institutions began offering mortgages.

Prior to 1930, they were small and generally only half the market value of a home.

These loans were generally short-term, with maturities of less than 10 years, and only two annual payments. The borrower has made either no principal payment or several such payments prior to maturity.

Borrowers must refinance their loans if they are unable to repay.

Rescuing the housing market

When America fell into the Great Depression, the banking system collapsed.

The housing market has collapsed as most homeowners are unable to repay or refinance their mortgages. The number of foreclosures he surpassed 1,000 a day by 1933, and housing prices plummeted.

The federal government responded by creating new agencies to stabilize the housing market.

They included the Federal Housing Administration. Provides mortgage insurance. Borrowers pay a small fee to protect the lender in case of default.

Another new agency, the Home Owners Loan Corporation, founded in 1933, bought defaulted short-term, semi-annual interest-only mortgages and turned them into new long-term loans that last 15 years.

Payments were self-amortizing monthly and covered both principal and interest. They were also fixed rate and remained stable for the life of the mortgage. Initially, they were heavily biased towards interest and later owed more on principal. This firm closed in 1951, where he made new loans for three years. Pioneered long-term mortgages in the United States.

In 1938, Congress established the Federal National Mortgage Association, better known as Fannie Mae. This government-backed company made fixed-rate, long-term mortgages viable through a process called securitization. That is, they sold debt to investors and used the proceeds to buy these long-term mortgages from banks. This process de-risked banks and encouraged long-term mortgages.

fixed and variable rate home loans

After World War II, Congress authorized the Federal Housing Administration to guarantee 30-year loans on new construction and purchases of existing homes years later. But then the credit crisis of 1966 and the years of high inflation that followed made variable rate mortgages more popular.

These mortgages, known as ARMs, have stable interest rates for only a few years. Usually the initial interest rate he is significantly lower than a 15 or 30 year fixed rate mortgage. After that initial term ends, the ARM interest rate adjusts up or down each year along with monthly payments to the lender.

Unlike other parts of the world where ARMs dominate, Americans still prefer 30-year fixed-rate mortgages.

Approximately 61% of US homeowners currently have a mortgage, and fixed interest rates predominate.

However, as interest rates rise, demand for ARM is increasing again. Unfortunately for some ARM borrowers, the term ‘dead pledge’ may live up to its name if the Federal Reserve fails to keep inflation in check and interest rates continue to rise.

Michael J. Highfield is Professor of Finance and Robert W. Warren Chairman of Real Estate Finance at Mississippi State University.

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