Do We Need the 30-Year Fixed-Rate Mortgage?

One of the central arguments in the ongoing discussion about the fate of Fannie Mae and Freddie Mac is the importance of the 30-year fixed-rate pre-payable mortgage (hereafter referred to as the FRM). David Min (2010) asserts that the FRM is an essential part of the U.S. housing finance system. Susan Woodard (2010) emphasizes the special role of the FRM and states that “Americans now seem to regard the availability of long-term fixed-rate mortgages as part of their civil rights.” Levitin and Wachter (2010} assert that the FRM is critical for sustainable homeownership. All three of these authors advocate continued government support of Fannie Mae and Freddie Mac in order to preserve the FRM.

The FRM clearly occupies a central role in the U.S. housing finance system. It has been the dominant instrument since the Great Depression and currently accounts for more than 90 percent of mortgage originations. The FRM is regarded as a consumer-friendly instrument, which is one reason why it enjoys enduring popularity. But the instrument can cause problems for both current and prospective borrowers. And part of its popularity is due to government support as well as past regulatory favoritism. The FRM is heavily subsidized through the securitization activities of Fannie Mae and Freddie Mac. These subsidies, which lower the relative cost of the instrument, are an important factor in its popularity. The FRM also imposes costs on the mortgage industry and on investors in mortgage securities—costs that are likely to rise as the economy recovers. Importantly, the FRM is a onesided design. Consumers, particularly those who utilize the prepayment option, benefit while investors and taxpayers bear the cost.

Are the benefits of the FRM worth the costs? Would the FRM disappear if Fannie and Freddie were no longer financing it? Are there mortgage alternatives that balance the needs of consumers and investors without exposing the taxpayer to inordinate risk? This paper seeks to answer these questions. We start with a brief history of the FRM from its creation during the Depression to the current day, emphasizing the ongoing role of the government in enhancing its presence. We then discuss the benefits of the FRM to the consumer and the economy. Following we explain the costs of the FRM to consumers, investors and taxpayers. We end with a depiction of a world in which the FRM is no longer supported by Fannie Mae and Freddie Mac.