How Mortgages Came To Be

You might think that the mortgages we know and enjoy these days have been around for 100’s of years.  But in reality, conventional mortgages have been in existence for slightly more than 70 years. The evolution of the mortgage is a fascinating story.

The Creation of the Mortgage

The idea of offering a mortgage did not originally come from banks or other lending institutions.  In fact, it came from the Insurance industry.

Lawyers, 150 years ago, as today, were responsible for making sure that property titles were registered accurately and properly.  It became apparent, through the court system, that a number of people were losing their homes because lawyers and notaries were giving erroneous title information.  Thus, title insurance was created in response to the need for reliable assurance to cover the loss caused by errors in reporting the status of title.  In 1874, Pennsylvania enacted the first statutes authorizing the issuance of title insurance.

From 1900 to the early 1930’s, the title insurance industry began to grow rapidly. The insurers were able to convince third-party lenders that title insurance was necessary for the financing of residential properties.

But mortgages back then were not as they are now.  In many cases, a person applying for a mortgage had to have an 80% down payment.  And the term of the mortgage was for 3-5 years, with interest being the only payments.  Then at the end of the term, the homeowner was responsible for a balloon payment, which meant they had to pay off the entire mortgage. 

A cynical view in those days was that the insurance companies were not in the business of making money though fees and interest, but rather, like a vulture, hoping that the homeowner could not make the final balloon payment, and thus lose their home.

The Great Depression

With the stock market crash of 1929, and the resulting depression in the early 1930’s, many people lost their homes and property because they were out of work and could not make the balloon payments on their mortgages.  Also, many lost their homes because they were unable to pay their property taxes.  

The Modern Mortgage

Shortly after the Great Depression, the Federal Government got involved.  The majority of people had become renters, not homeowners.  So, to get the American population back into home ownership, the Federal Housing Administration developed the modern mortgage in 1934.

The modern mortgage included these changes:

• An 80% loan to value amount (LTV).  Potential homeowners only had to come up with a 20% down payment.  Banks and other lending institutions followed the same policies.

• The FHA also started the practice of qualifying people for mortgages, to ensure that they could afford the payments.  Up until that time, quite often a mortgage was granted to people based on “who they knew”.

• The length, or term, of the loan was increased to the standard 15 years, and eventually 30 years.

• The FHA ensured that houses had to meet specific quality standards to be eligible for a mortgage.  Traditional lending institutions followed the same practices.

• The FHA also created the “amortization” of mortgages.  As mentioned earlier, people were losing their homes because they couldn’t come up with the balloon payment at the end of the loan term.  With amortization, homeowners could now pay a little bit of the principal every month, instead of just making interest payments.  At the end of the loan term, no balloon payment was necessary.

• And the FHA ensured that all lending institutions employ Escrow Mortgage accounts.  That meant that with every monthly payment of interest and principle, the homeowner would also pay a little bit extra to cover insurance and property taxes (PITI – Principal, Interest, Taxes, Insurance). The lending institutions would make the payments to the government on behalf of the homeowner.

Finally, after the Second World War ended, the government wished to lend Veterans money for mortgages so they could own homes as well.  They extended the regular term of the mortgage from 15 to 30 years.  It was so popular that conventional banks and lending institutions followed suit, and we haven’t looked back since.

About The Author

David Morris is a successful freelance writer providing tips and advice for consumers on mortgages, personal loans and equity loans.  Many have commented that his articles have made financial topics easy to understand.

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