Solution #2 - Redesign U.S. Mortgages to Maximize Home Ownership Instead of Home Sales

Not Easy But Effective

Redesign U.S. mortgages to maximize the free-and-clear home ownership rate over the long run instead of maximizing home sales over the short run. See Secret #31. Redesign U.S. mortgages to protect home owners over the long run, not just banks and mortgage lenders. 

The focus of U.S. mortgage policy is on maximizing home sales in the short term without looking at the long-term effects of those policies on home ownership rates. U.S. mortgage policy has been very shortsighted and the home ownership rate is about the same as it was in 1970. 

Some mortgage designs can lead to higher home sales and higher home ownership now, but more foreclosures and lower home ownership in the future. In the long run, “affordable” mortgages can increase house prices and mortgage debt, NOT home ownership, as we've seen. See Secret #38.

In combination with the One Tax Code for Homes, redesigning our mortgages would greatly stabilize house prices and increase home ownership, household wealth, and U.S. economic growth. But, redesigning U.S. mortgages is a TON more complex than implementing the One Tax Code for Homes, so do the One Tax Code for Homes first.

Ideally, we can find solutions that reduce booms and busts and don’t need to be changed during booms or busts. Solutions that depend on changing X when Y happens (for example, tightening mortgage lending when house prices start increasing fast) usually depend on humans making the right decisions at the right time which doesn’t always happen. This is a disadvantage that needs to be taken into account when evaluating these “leaning against the wind” solutions. 

Design of Mortgages

Easiest Mortgage Solution. Stop making things worse.  

Helping investors lowers home ownership. We should end all government, and government-sponsored, mortgage programs for home buyers who do not actually live in the homes themselves as their primary home. Those investor mortgages for single-family houses and condos directly lower the home ownership rate. Those mortgages also destabilize house prices, family wealth, and U.S. economic growth. Private sector lenders should handle private sector investors without any government help whatsoever.

Safer Mortgages.

The real estate industry HATES tightening lending standards but standards that lead to more home ownership in the long run, not just the short run, should be the goal for the United States.

The government should encourage the use of safer mortgages in its government mortgage programs and incentives, and prohibit high-foreclosure mortgages entirely and everywhere. 

Qualified Mortgage Rules. The “qualified mortgage” rules of the Consumer Financial Protection Bureau greatly reduced the number of risky mortgages we have today but they still allow home buyers to take on too much debt. The maximum debt-service-to-income ratio is currently 43% but with a lot of exceptions. It should be greatly reduced over time and have no exceptions. 

When home ownership boomed in the 1940s and 1950s, the average debt-service-to-income ratio was FAR, FAR less than 43%. If we lowered the max QM DTI ratio, in the future we’d see U.S. house prices increase less in booms and decrease less in busts. If the qualified mortgage rules emphasized debt-to-income instead of debt-service-to-income, that simple change would greatly stabilize house prices and household wealth while increasing U.S. economic growth. 

LTV and DTI. The standard mortgage safety features like minimum down payment percentage (LTV), debt-to-income ratios, and credit history should be fine-tuned for safety over the long run. Set a standard, say, only mortgages with an estimated default rate of less than 4% in the next mega recession are allowed. See Secret #30. If a policy is added that makes homes more affordable but also increases their foreclosure rate in housing recessions then the policy must also include measures to reduce foreclosures in housing recessions to get back to the goal, say a 4% default rate in a mega recession.

Be aware that whatever you set the maximum allowed estimated default rate at, some neighborhoods will have default rates FAR, FAR above your maximum. See Secret #37.

DTI vs DTI. What we call the debt-to-income ratio in the U.S. is really the debt-service-to-income ratio. Debt is the total amount of debt. Debt service is the total amount of monthly debt service payments. Some countries focus on the debt-to-income ratio, for example, they say your total debt, including your mortgage, can only be up to a maximum of 3 or 4 times your annual income, depending on the country. This adds some market stability when interest rates fall because you can’t borrow more money when interest rates fall. 

In the U.S., however, lower interest rates are soon “monetized” and become higher house prices. The transmission of interest rates into higher home prices is smaller in countries that focus more on the real DTI ratio when qualifying home buyers for mortgages.

Shift from DTI to Debt-to-Rent Ratio. Base the maximum loan amount on the amount of rent a house would support. 

20-Year Mortgages. Can the U.S. transition back to 20-year mortgages? They’re standard in many countries. We could lower the maximum qualified mortgage term from 30 years to 20 years over many years. Or perhaps when rates fall, we can somehow shorten the length of mortgages instead of increasing the amount that can be borrowed. 

Increasing the amount that can be borrowed just increases house prices and so leaves home buyers no better off. Perhaps instead of giving tax credits to first-home buyers to spur home purchases that drive up prices, we have programs to shorten mortgage lengths to increase free-and-clear home ownership in the long run. How would you like to have 10 years fewer mortgage payments? See Secret #42.

Lower-Only Adjustable Rate Mortgages. Can we make Lower-Only Adjustable-Rate Mortgages (LO-ARMs) standard, at least for FHA and VA, which would greatly lower foreclosures and greatly stabilize the economy during recessions? See Secret #44.

Portable Mortgages. Portable mortgages would help in some situations, like today, especially if we develop first-home buyer mortgages that have special features that are only available to first-home buyers. Being portable allows those first-home buyers to move the rest of their mortgage, and its special features, to their second house. See Secret #43.

Loan Limits Footage Limits. To better target government-sponsored and government mortgages to first-home buyers, and reduce the size of future real estate booms, change from limits on the size of the loan that qualifies to limits on the size of the house that qualifies for those loans. See Secret #40.

IDEAL MORTGAGE. 20-year, Lower-Only Adjustable-Rate Mortgages (LO-ARMs) that are portable for first-home buyers.

Process Improvements. A lot of policy and process improvements can be made to increase mortgage safety. The VA has a lower foreclosure rate than the FHA despite VA having a lot of zero down payment mortgages. The VA has a lot of policies and processes that reduce foreclosures at no cost. 

• FHA covers 100% of mortgage industry losses which leads to high-foreclosure mortgages. The industry needs more skin in the game. Reduce FHA mortgage insurance to 25% like VA mortgages. 

• In addition, the FHA should copy the VA’s appraiser management systems which lead to more accurate appraisals and fewer foreclosures. For example, have VA, FHA or Fannie & Freddie select the appraiser, NOT the lender. See Secret #49.

• In addition, the FHA should copy the VA’s use of “residual income” to make sure the mortgage isn’t too much for the home buyer and to reduce future family foreclosures.

Automatic Price Stabilizers. When home prices increase X% faster than inflation, then Y automatically kicks in. 

• When house prices boom then credit scores, debt-to-income ratios, or down payments, or whatever, are automatically tightened which taps the brakes on skyrocketing house prices.

• Can we make it so that when interest rates fall, mortgage length automatically gets shorter?

• To increase the supply for sale when prices are increasing fast, can we automatically reduce the capital gains taxes on the sale of investment single-family homes?

Microprudential Automatic Stabilizer. Similarly, do 2 appraisals on each house – its current estimated value and its value 1 year earlier. If the appraised value has increased X percentage points more than inflation over the last 12 months, then the minimum down payment is increased or other safety adjustments are made.

A zillion other improvements could be made to home mortgages. 

Cramdowns. A simple change in bankruptcy legislation would make the worst real estate busts a lot less bad in the future. See Secret #71.

Design of the Mortgage Industry

“All-in-One” Mortgage Banks. It would be nice during future real estate downturns to have a mortgage system that isn’t (unintentionally) designed to foreclose fast and make downturns far larger than necessary. Maybe something more like the old Savings and Loan system or the system in Denmark, Sweden, and Hungary, where the government is less involved and the same company that sells the mortgage also services it and owns it. When the same company originates, services, and owns the mortgage, all the principal-agent problems that we often see in the U.S. mortgage industry simply disappear.

Then when a home owner has a problem, the mortgage company has a lot more motivation and power to work out a solution with the home owner, instead of just foreclosing as fast as legally possible like under the current U.S. system.

These mortgage systems have been extremely stable. Denmark has had the same “covered bonds” mortgage system since the 1800s. The U.S. has gone through 3 or 4 traumatic makeovers of our mortgage systems over that time period. Remember when Savings & Loans were the U.S. mortgage system and remember when they failed? 

That all-in-one, “covered bonds” mortgage system creates safer mortgages without all the government involvement. They’re just naturally safer because the interests of the originator, servicer, and holder of the mortgage are the same because they’re the same company.

Spain had a HUGE real estate bubble in the 2000s and afterward has spent years slowly converting to an all-in-one, covered bonds mortgage market.

Instead of trying to figure out what parts of the current government and GSE mortgage system can be changed, let's figure out the mortgage system we want and create it alongside the current system.

The mortgage industry changed dramatically from the S&L Bubble to the 2000s Bubble and then changed dramatically again since then. If the mortgage industry is constantly changing anyway, why don't we design the next changes to maximize free-and-clear home ownership and American family wealth.

Government Purchases. If they wanted to, the U.S. government could create an agency similar to the original Fannie Mae – or perhaps have the Fed do it since they have a history of buying MBS – to buy the mortgage bonds (MBS) backed by these safer mortgages that are originated, serviced and owned by these federally regulated all-in-one mortgage banks – at least at the beginning to help these new all-in-one mortgage banks get established. Or perhaps a Central Housing Bank makes the purchases instead of the Fed.

In addition, they would help transform the U.S. home mortgage system and increase home ownership if they only bought MBSs backed by safer, sustainable, lower-foreclosure mortgages – such as 20-year mortgages – from these mortgage banks. This style of QE would lower the interest rate for those safer mortgages only and increase the use of safer, wealth-building, mortgages. 

Stop Lenders from Dumping their Foreclosed Houses on the Market. Stop mortgage lenders from dumping their mistakes on neighborhoods and lowering house prices for home owners who did nothing wrong. Maybe we should say lenders, including FHA, Fannie and Freddie, after they foreclose, can’t sell houses for less than their original, lender-approved, sales prices, certainly not less than the original, lender-approved, loan amount. The lenders would have to buy their own mortgage insurance and that would protect neighborhoods.

In addition to forcing home buyers to buy more mortgage insurance to help protect the lenders from foreclosures, we would also force lenders to buy mortgage insurance to help protect neighborhoods from lenders making high-foreclosure mortgages and then dumping their foreclosures into innocent neighborhoods.

There are many other different types of mortgages used throughout the world to choose from.