3 reasons to save the 30-year fixed mortgage
FORTUNE — As Washington talks about the future of mortgage finance giants Freddie Mac and Fannie Mae, some are asking if Americans should continue having easy access to a popular mortgage — the 30-year, fixed-rate home loan.
It has been around for decades. Banks typically don’t like to hold onto the risks of these long-term loans, but they’ve continued to dominate the mortgage market mostly because Freddie and Fannie buy these loans from lenders and sell them to investors with a government guarantee they’ll be repaid.
Following the financial crisis, when bad loans exposed U.S. taxpayers to billions of dollars of losses, lawmakers are debating what kind of role should the government play in the mortgage market. As Americans await the outcome, which likely won’t come any time soon, here are a few reminders why the 30-year fixed mortgage is a critical part of a healthy housing market:
They help borrowers manage risks
Wall Streeters may spend all day analyzing the risks of investments, but data suggests average borrowers aren’t so good at this, says David Min, a law professor at the University of California, Irvine. Min, who has written how government guarantees promote financial stability in the housing market.
Borrowers are less likely to go seriously delinquent (90 days or more) with a fixed-rate mortgage vs. those with variable rates. During the second quarter of 2011, as borrowers struggled to recover from the crash of the housing market, the rate of serious delinquencies for prime 30-year fixed mortgages was 4.74%, while adjustable mortgages were delinquent at a much higher rate of 11.76%.
“Overall it’s just a product that people understand,” says Min, an expert on financial regulations who recently authored the article, “How Government Guarantees Promote Hosing Finance Stability” in the Harvard Law School Journal on Legislation. “All the research suggests that consumers are very, very bad at predicting interest rate risks.”
The question is who bears the risk? More than that, can the economy trust borrowers to do it?
They can stabilize economies
The 30-year-fixed rate mortgage has long been a staple of the mortgage market for a reason: It helps limit macroeconomic instability, according to a 2004 report on mortgage market reform in the U.K. by David Miles, currently a policymaker at the Bank of England.
In countries where short-term or adjustable mortgages dominate the market, changes in short-term interest rates had a much larger impact on home prices and are far more vulnerable to extreme bubble-bust cycles in the housing market.
This makes sense, since borrowers may not be able to afford higher payments if interest rates rise. While the 30-year fixed dominates the U.S. market, recall in 2007, one of the triggering factors of the U.S. housing market crash was that many subprime adjustable-rate mortgages reset to much higher interest than what borrowers were paying during their first few years.
They make our dream homes more affordable
It’s rare for most borrowers to live in their homes for three decades, but the 30-year fixed has long made homes more affordable to most Americans. Of all mortgage applications for home purchases in July, 82.6% were for 30-year fixed loans.
By allowing borrowers to stretch out payments for a longer period of time at a fixed rate of interest, they can buy more house. True, many would argue that borrowers should scale down their expectations, but it’s also a critical time to continue giving Americans relatively easy access to the 30-year as the housing market continues to recover.
Interest rates have been rising and likely will rise further over the next several years. It would be the wrong time to push more people to adjustable-rate loans.