If you understand the historical perspective mortgage rules & procedures will make a lot more sense.

Mortgages, as you know them, started with the advent of FHA back in 1934.

"Its a Wonderful Life" with Jimmy Stewart is a good period piece to show how radical a concept FHA was. What we take for granted today was considered very radical, and largely unbelievable at that time. As a matter of fact, the movie didn't do too well when it was first released because the Bailey Thrift's actions were too bizarre. Lenders didn't do things like that back then so it detracted from the show!

Regular lenders and banks would not make these radical new FHA loans so Insurance companies funded the first loans. The major motive for loans prior to this point, from a lender's point of view, was not just to collect the interest, but the hope the borrower would not be able to make the payments and the lender would get the property in foreclosure.

Remember the old Maverick TV series? In almost every show Brett Maverick rode into a new town and there were signs all up and down the street that read something like: Johnson Livery Stable, Johnson Hotel, Johnson Savings and Loan, Johnson this and Johnson that. How do you think Johnson gained control of the town? These practices gave banks and mortgages quite a black eye.

FHA changed all that!

Now, there is a foreclosure procedure that ensures the Johnsons can't get control of the property (and the town) unless fair market value is paid. (see also Underwriting Guidelines for more on on the foreclosure process)

In the 1930's a lot of things were far different than we take for granted today.

THEN an 80% loan meant you put down 80%. It was almost considered a sin to have to borrow money to buy a home or anything. The unavailability of loans and the public attitude towards loans contributed to home home ownership figures of less than 20%. The government wanted to get home ownership to 80% so they decided to help the common people own a home. FHA was the vehicle they created. You have FHA to thank for being able to own a home. FHA developed the models for 80% LTV, 90% LTV, 95% LTV, & 97% LTV loans plus many other things we take for granted today:

 

Loan To Values (LTV)
Fast forward to a period that mortgages were considered acceptable and as FHA lowered their downpayment requirements Conventional lenders followed suit. So even tho FHA is not all that competitive today for most people, I am glad it is around because it keeps VA and Conventional loans honest & competitive.

 

Modern day qualifying standards
The concept of qualifying someone for a loan was a radical idea. In the good ol' days they gave you a loan because they knew you. In those wild west towns that Maverick visited, the town drunk could get a loan easier than a newcomer. FHA pioneered looking at your income, outgo and credit to see if you had the capacity to make the payments.

 

Long term loans
A 5 or 7 year loan was considered long term back then. FHA started the 15 year loans and gradually grew the term to the 30 years we consider the norm.

 

Building standards
I hate to keep going back to old TV shows & movies, but they are our best windows to days long gone. Look at the construction quality of the homes in the old B&W movies. Except for the rich people, the homes had little resemblance to the construction quality we see in even the cheapest of homes today. They had no insulation, wiring was often exposed, the houses leaked and leaned. Sheet rock? What's that?

FHA decided that if they were going to make long term loans, the buildings had to last long term. So they developed standards for foundations, wall studs & bracing, heat & A/C systems, insulation, windows, sheetrock, and much more. Even the quality of carpet has benefited greatly from these standards. Of course today we think of FHA standards as being very cheap, but back then they were radical and were considered very expensive.

 

Amortized loans
Before this time most loans were interest only balloon notes. You made interest only payments and never reduced the principle. After paying on a house for 5 years you still owed the same amount of money. This meant that at some time you had to be able to totally pay the purchase price of your house in one lump sum. It was no wonder Mighty Mouse was always having to save Pauline Pureheart's farm from foreclosure. A bad crop meant the farmer could not pay the loan off and since the bank did not have to renew the note . . . the Johnson's of the day amassed quite a fortune foreclosing on loans. FHA decided it would be easier & safer for the consumer if they paid an incremental portion of the loan along with each payment (amortization) rather than having a lump sum payment always hanging over their heads. This meant that at the end of the term of the loan you had a zero balance instead of still owing the full balance.

 

Budget loans
Along those same lines, FHA realized it would be easier for people to pay their insurance and taxes a little each month rather than having to save up to pay a large lump sum and so was born the Budget loan. The Budget loan payment includes Principle, Interest, Taxes and Insurances (PITI).

This type of loan has an added security factor to the lender in that now they are sure the insurance and taxes are paid in a timely fashion. If a house burns the lender is covered. Likewise, since tax liens take precedence over mortgage liens, the lender is sure taxes are always paid.

Lenders originally enticed people to do these Budget loans by offering them slightly lower rates. Budget loans and low rates are the norms nowadays. If you would like to pay your own taxes and insurance you can, but it will cost you. Quoted rates presume a lender controlled escrow account. If you want to pay your own taxes & insurance Lenders will want you to put down more than the minimum downpayment and they will typically charge you $250 or 1/4%.

 

Mortgage Insurance
FHA loans were so popular they soon outstripped FHA's capacity to fund the loans. So Mortgage Insurance was formed to reduce the risk factors and attract other investors which greatly expanded FHA loan's availability.

What MI basically does is cosign the note with the borrower. I don't know what coverage level the first MI had, but most MI today reduces the risk to the investor to around 80%. This means that every loan made with MI is basically an 80% loan no matter how little the borrower puts down.

If the borrower does not make the house payments and lets the house go into foreclosure the MI company pays the loan down to the 80% level. For example: on a $100,000 home if the borrower put 5% down and then never made a payment the MI company would pay the lender $15,000 so that the lender only had $80,000 at risk. (see also Underwriting Guidelines for more on that)

I don't want to sound like I am trying to push FHA loans and have someone get mad at me when they try to get one and find it doesn't fit their situation. As they say, the only thing you can count on is change and FHA has changed quite a lot over the years. Now they are only the "loan of choice" for a small percentage of the public anymore. FHA is now typically for people with major credit problems ("B" credit) &/or loans under $55,000.

Eventually FNMA was formed to buy these FHA loans from mortgage companies to free capital up so even more loans could be made.

This worked so well and opened loans up to so many people that FNMA (Fannie Mae) eventually started buying Conventional loans as well. FNMA and mortgage companies did so well that in the 1970's FHLMC (Freddie Mac) was formed to buy loans from S&Ls so they could be competitive too.

A little known fact is that Mortgage Brokers basically started the whole mortgage process. Long before the 1930's Mortgage Brokers funded the money that allowed America to be successfully colonized. Brokering developed the Thrift organizations which further developed Brokering which developed the S&L's which re-developed Brokering. Competition is a wonderful thing!

Out of the 200+ years since America was founded, housing has been a very poor investment for over 150 of those years.

People bought or built a home because they wanted or needed a home, not to make money. In the 1950's that started changing. In the 70's when, for the first time, we were able to count a woman's income we had inflation like nothing ever seen before. We suddenly had people with almost double their "qualifying" income and they wanted to use it all! This created a greater demand than the market could bear and as they say, the rest is history!

Yes, I did say, "when, for the first time, we were able to count a woman's income". Prior to that time to be able to count a woman's income she had to be a nurse, teacher or "other professional" AND EVEN THEN you only got to count 50% or LESS! I remember when a woman was of "baby bearing age" having to get a note from her doctor stating she wasn't going to have a baby anytime soon (like he would know). Even then we were only able to count 10-20% of her income!! Times certainly have changed!

It would be an understatement to say that the ten year period of 1977-1987 was very different from the norms. We are back to a more normal situation now. People really should buy homes because they want a place to call their own or a place to live. It may never be that simple, because people still hope for a good investment. Things will be simpler and are more likely to meet your expectations when you focus on the ownership aspect. That doesn't mean you can't /won't make money on a home, but that shouldn't be your primary focus.