What Is the Origin of FHA Mortgages?
- Owning a home of their own had long been a dream for most Americans, but the mortgage lending practices of American banks through the end of the 1920s made it an unrealistic dream for a large number of people. Mortgages during that time were short-term, interest-only loans that required a down payment of as much as 50 percent. Because of this, less than half of all Americans owned a home prior to 1934. Due to the lack of a national market for mortgages, rates varied widely between regions by as much as 2 to 4 percent, and interest rates were relatively high. Mortgage loans were typically five-year loans that ended in a balloon payment of the entire original principal balance at the end of the loan. This meant that homeowners had to refinance every five years and never paid down any principal, unless they paid extra on their loan. If they were unable to make their payments or refinance by the end of the loan, the bank could foreclose and the homeowner would lose all their down payment money along with whatever equity built up from an increase in property value.
- When the stock market crashed in 1929, lenders tightened their standards, leaving many homeowners unable to refinance their mortgages. Foreclosures became common and the market was flooded with homes for sale, decreasing the value of all homes. Construction dried up and contributed to the already high unemployment numbers. A large number of Americans were jobless and rootless, which fed the psychological instability present at the time. Building upon the Federal Home Loan Banking System created in 1932, Congress passed the National Housing Act of 1934.
- The National Housing Act of 1934 established the FHA as a self-funding branch of the federal government and charged it with insuring mortgages offered by participating lenders. The FHA would reimburse against any losses to the lender from foreclosure in exchange for their adherence to FHA guidelines. This made banks more willing to lend and opened up financing for a larger pool of buyers.
- FHA mortgages changed the face of the mortgage industry by creating 25-year amortized loans with much lower down payment requirements, eliminating frequent refinancing and reducing foreclosure. Amortized loans allowed homeowners to own the home outright by the end of the loan because they devoted a portion of each month's payment toward paying down the principal of the loan. FHA guidelines also required minimum property standards, which promoted safe, sanitary housing. The development of a national loan program spurred competition among lenders, which helped bring down loan costs and interest rates. The result was more homebuyers qualifying for more loans, which in turn boosted the housing and construction markets.