We are enjoying a level of single family home sales, both new and existing, higher than ever before in our history. This boom has been spurred by a sharp increase in the number of families in the home-buying age bracket and a plentiful supply of mortgage funds.
The demand for homes is expected to continue at a high level well into the 1980s. It is uncertain, however, whether mortgage funds will be as readily available.
Already there are indications that the supply of funds available for mortgage lending may be falling behind the demand, even at today's interest rates of about 9 per cent. The increase in savings at thrift institutions has not kept pace with the demand and there has been no significant switch into mortgage lending in by other major holders of savings such as insurance companies and pension funds.
Even more disquieting are the recent actions of the Federal Reserve to tighten up on the money supply by forcing up short-term interest rates. Its efforts are bearing fruit, raising the question of whether long-term interest rates, such as one home mortgages, will also start to increase. If they do, it will become more difficult to buy and finance a home.
Another result could be an outflow of savings from the thrift institutions. This is called disintermediation. If this should occur, there will definitely be less money available for home mortgages and the money that is available will carry considerably higher interest rates.
Disintermediation occurs because savers can obtain higher rates on their savings from other investments, such as Treasury bills. The thrift institutions are unable to adjust their rates high enough to compete with these other opportunities because their portfolios of mortgage loans have a substantial number of loans carrying the lower interest rates of earlier years.
This was what has has happened several times in the past, most recently in 1973-75. During that period the thrift institutions has practically no money for new mortgage lending and what little was available carried high interest rates. Home building and the sale of existing homes fell dramatically.
One partial solution suggested by the thrift industry is to develop and use new types of mortgage forms. The present form of home mortgage in use in this area and in most other parts of the country provides for a level mortgage payment at a set interest rate over the full life of the mortgage, which will commonly be 25 to 30 years. The first payment and the last payment are the same. Many lending institutions contend that this form is obsolete, in view of the volatile inflationary economy the nation has been experiencing in the last decade. The adequate interest rate on the mortgage written five years ago may well be totally inadequate in relation to what the institution must pay for savings today, they state. Some of the alternatives are the variable rate mortgage (VRM), the Canadian rollover mortgage and the graduated payment mortgage (GPM).
The variable rate mortgage is the alternative most often suggested. It has been used quite extensively by state-chartered S - Ls in California in recent years. (Federal S&Ls are not permitted to the VRMs.) Under the VRM, as its name connotes, the interest rate varies periodically, based on the variation in some predetermined index of the cost of money. Although this variation may be only upwards, most VRMs contemplate variations both ways. As the rate changes, the monthly mortgage payment also will normally change. However, some VRMs permit the mortgage payment to remain unchanged with any additional interest costs added to the end of the mortgage term.
Rate changes are usually calculated every six months, although periods as short as three months and as long as one year are occasionally used. There is usually a maximum amount the rate can change each time, along with a maximum cumulative change which normally has been 2 1/2 per cent. To induce borrowers to choose a VRM over a regular mortgage, many lenders offer a slightly lower initial interest rate.
The key to the VRM is the index of the cost of money to which it is tied. The purpose of the index is to permit the lending institution to adjust what it earns on the money it lends to reflect the cost of that money. The simplest index is one which reflects the average interest rate paid on the savings in the individual lending institution. Other indices in use or proposed rely upon broader measurements of the cost of money. For example, S-Ls in California use an index maintained by the Federal Home Loan Bank of San Francisco which reflects the cost to California S-Ls of savings, borrowings and advances by the Bank.
The Canadian rollover mortgage is so-named because it has been used extensively in Canada in recent years. Under it the mortgage is written for a five-year term but with payments as if the mortgage were going to last for a regular period of 25 to 30 years. The interest rate remains unchanged during the five years, but at the end of the five years the borrower must either pay off the remaining principal balance or agree to a new mortgage at the interest rate then charged by the lender. It is thus a form of variable rate mortgage.
The graduated payment mortgage is different from the VRM and the Canadian rollover in that the interest rate does not change. Instead, the borrower is allowed to make payments in the early years of the mortgage term at less than level rate normally required and to make up these lower payments in later years by making a higher than normal monthly payment.
Each of these three alternative mortgage forms, as well as others not described, are aimed at making it possible for more people to buy their own homes. The VRM and the Canadian rollover have been designed to assure that mortgage money will be more readily available regardless of its cost, and the GPM has been designed to make it easier to borrow this high-cost mortgage money.
All of these alternatives have one inherent problem - they do not deal with the high cost of mortgage money; they merely attempt to accommodate to it. For the buyer who cannot afford today's interest rate, a VRM, with the potential of an even higher interest rate and higher monthly payments in the future, will become an even bigger hurdle. While the GPM will enable some to buy who might not otherwise qualify, if they can afford its higher than normal down payments, the scheduled increase in monthly payments will result in only the upwardly mobile being helped.
The Canadian rollover, with its required renegotiation every five years, has already run into trouble in Canada, where the lending institutions are looking into the possibility of VRMs.
The real problem, of course, is inflation which has brought us the highest interest rates in our history in recent years. Because of inflation, lenders feel that they must factor in an inflation increment in their rates. On the other hand, money also responds to supply and demand factors like other goods or commodities. If the supply of money is plentiful, interest rates come down.
Unfortunately, the Federal Reserve feels that the best way to fight inflation is to tighten up on the money supply, as it is now doing, and thereby drive up interest rates. To those uninitiated in the economic logic of the Federal Reserve, it is difficult to understand how increasing the cost of money will result in decreasing the rise in the cost of those items, such as housing.
In the case of housing, these periods of tight money (3 in the past 10 years) have resulted in decreased production, aggravating the supply problem and in a higher level of mortgage interest rates.
What is really needed is lower cost mortgage money in sufficient quantities to meet the reasonable aspirations of the American people to own their own homes. This will require a lessening of inflation, but it will also require a change in the way that the Federal Reserve deals with the money supply.
Carl A. S. Coan Jr. is a private attorney and housing consultant in Washington. He formerly served as staff vice president for governmental affairs and legislative counsel of the National Association of Home Builders and as an assistant general counsel of HUD. He is presently serving as a public member of the Joint Subcommittee of the Virginia General Assembly studying alternative mortgage instruments on residential home loans.