I read an research paper contrasting US mortgages against the rest of the world’s mortgages, and thought I would share the interesting bits with you guys. Now, I just want to say that this was written in 2010, and for all the non-US mortgages, I’m pulling my information on them from this paper. If things have changed in your country since then, or it has something wrong. Please do let me know!
The Dodd-Frank Act, a piece of regulatory legislation that came out after the 2008 crisis, proposed the following important portions concerning the mortgage market:
Prepayment penalties: Limited to a 2 percent cap for the first 3 years of the mortgage. Not allowed on variable rate mortgages. Due to market competition, a majority of the biggest banks offer loans without a prepayment clause.
Interest Only/Balloon Payments: The majority have been eliminated, but you can still find them out there by smaller banks. Commercial or business owners tend to use these more. There are more stringent requirements, with some banks only giving these out to accredited investors.
Qualified Mortgages: Banks can also give out unqualified loans, but would then be subject to 5 percent of the credit risk on the loans.
It’s worth noting that there is nothing inherently wrong with the mortgage designs above, but that salespeople were going out and selling loans that normal people didn’t fully understand the risks. Commercial loans are not infrequently structured with prepayment penalties and with Interest Only/Balloon payments.
So, why can other countries offer these and be ok, while it blows up in the US’s face?
The US is one of the only countries in the developed world to have government sponsored entities that are mandated to buy up qualified mortgages. The US created GSEs in the 20th century to allow more home ownership. If GSEs were mandated to buy qualified mortgages from banks, then banks could free up capital and in turn create more mortgages for people. Do we see the problem here? If an end entity that is implicity backed by the government is buying up all the mortgages created, there is no incentive other than to check that it meets the government’s boxes.
South Korea is one of the only other countries with GSEs, but they don’t offer government mortgages insurers. Canada has government mortgage insurers but not GSEs. Japan has some GSEs, but with the 1990 Japanese asset price bubble, it seems fitting that Japan’s Mortgage debt to Outstanding GDP ratio is 35 percent, while the US’s is 95 percent. Don’t be alarmed by the US’s ratio though, check out the ratios of these other developed countries.
Different Mortgage Characteristics
1). Interest Rates
Look at the US! We’re almost all fixed rate mortgages. You can lump in the green and orange together as both basically variable rate mortgages. For medium term mortgages, the interest rate resets every 1-5 years.
Where are all the ARMs that the US was in an outcry over? From 2004-2006, 30-35 percent of loans were ARMs. As you can see, they were quashed by 2009.
It’s worth noting that the US does not have the most complex loans out there. Half of Japanese loans are convertible, meaning you can pick either a fixed or floating rate at the end of a medium length period.
Sure, that sounds like a great idea! I’m sure everyone there is just sitting there with a spreadsheet trying to guess what the interest rates will be like over the course of the next five years and calculate which one would be a better deal. A number of other countries offer the ability to take out multiple loans on the property, with a different kind of loan on each one — perhaps one is fixed and the other is short term fixed, and the third loan is medium fixed. Who thought it was a good idea to let this happen? Lastly Canada, France, and Japan offer fixed monthly payments, with the term of the loan being adjusted when interest rates change. Seriously?
2). Prepayment penalties
US mortgages benefit the borrow the most when it comes to prepayment penalties. As a borrower, you don’t have to pay them and can get your loan refinanced when interest rates fall. The mortgage lender loses out because now they’ll have to lend the money you borrowed at a lower rate and collect less interest on it.
3). Average Time to Foreclose
4). Where is the funding from?
5). Origination Costs
The average cost of originating a loan in Europe is 1.1 percent, while US costs are much higher.