From AEI's Ed Pinto, writing in today's Real Clear Markets:
"Given two spectacular failures of U.S. housing finance tied to the 30-year fixed-rate mortgage in the last 20 years (MP: The S&L crisis and the recent housing/financial meltdown), and the attendant cost to taxpayers of two massive bailouts, the housing industry should be required to show why it needs government support again.
History has shown--and simple economics would anticipate--that a government subsidy for a freely prepayable 30-year fixed-rate mortgage is not good policy. This subsidy causes most borrowers to choose the 30-year fixed-rate loan, since in general it offers a fixed low monthly payment with a government-subsidized free prepayment option. Supporters point to the apparent stability it provides to borrowers. This stability is akin to the eye of a hurricane."
MP: Ed points out that the 30-year fixed-rate mortgage would likely be offered by private lenders in a mortgage market that was not distorted by government policies and intervention. But those 30-year mortgages would be priced accordingly, likely with higher interest rates than any other mortgage product, especially for mortgages with no pre-payment penalty. For example, here's a schedule of mortgage options that might be offered today, based on true market rates:
1. 6.00% 30-year fixed-rate term with no prepayment fee
2. 5.625% 30-yr. fixed-rate term with a 3%-2%-1% prepayment fee
3. 5.375% 30-yr. amortization with 15-yr. fixed-rate term and 3%-2%-1% prepayment fee
4. 5.375% 15-year fixed-rate term with no prepayment fee
5. 5.125% 15-year fixed-rate term with a 3%-2%-1% prepayment fee
6. 5.00% 7-year ARM with 30-year amortization underwritten at fully indexed 7-year rate with no prepayment fee
7. 4.75% 7-year ARM with 30-year amortization underwritten at fully indexed 7-year rate with a 3%-2%-1% prepayment fee
Bottom Line: It's not that the 30-year fixed-rate mortgage is inherently bad, but it's the government support and subsidy of those mortgages that has distorted mortgage and housing markets, and contributed to two serious banking and financial crises. We shouldn't end the 30-year fixed-rate mortgage, but we should end the government support and subsidy of those mortgages.