A History of Mortgages: How The FHA Regulated The Real Estate Business

In the old days, when someone wanted a home loan, he or she would walk downtown to the neighborhood bank. If the bank representative knew the customer and considered the person a good credit risk, then the customer would get the loan.

Mortgage loan terms were not customer-friendly in those days. Loan terms were limited to 50% of the property value, and the repayment schedule was spread over three to five years, and ended in a balloon payment.  America consisted primarily of renters, and only four in ten households owned their own homes.

It wasn’t until 1934 that the Federal Housing Administration (FHA) played a critical role in helping the country out of its economic depression. FHA initiated a new type of mortgage aimed at those folks who did not qualify under the existing loan programs. FHA lengthened the loan terms from the traditional 5 to 7 year loan to 15 year loans and eventually to the 30 year loan term, which is common today.

FHA started a program that lowered down the payment requirements. It set up programs that required a 20% down payment, a 10% down payment, and lower. This forced banks and lenders to change their loan terms, creating many more opportunities for average Americans to make their dreams come true and own their own homes. FHA also started the trend of qualifying people for a loan based on their actual ability to pay the loan, rather than the old way of simply knowing someone.

Another trend that FHA enforced was to ensure the quality of the home’s construction. FHA set standards that homes had to meet to qualify for the loan that are still enforced to this day.

Before FHA, traditional mortgages were interest-only payments that ended with a balloon payment that amounted to the entire principal of the loan. That was one reason why foreclosures were so common. FHA established the amortization of loans, which means people got to pay an incremental amount of the loan’s principal amount with each interest payment, reducing the loan gradually over the loan term until the loan was completely paid off.

Renting Vs. Homeownership

Is it better to rent or own a home? This is a complicated question that requires an understanding of leverage and rental equivalency.

Understanding Leverage

Leverage is the use of borrowed money to increase the potential return on an investment. For example, suppose you purchase a home for $170,000 with a down payment of $17,000 and your home appreciates at the average rate of 6% a year. In 10 years, your home would be valued at more than$304,000. That means your down payment of $17,000 would have grown to $151,000 in home equity.

The growth in your home equity represents a return of 24% on your original investment. Another factor to consider is the principal reduction. Remember, as homeowners  continue to make their mortgage payments, they continue to pay down the mortgage balance, which can be added to the leverage principal.

Understanding Rental Equivalency

Mortgage interest and real estate taxes are still the only major write-offs available for the majority of Americans. These deductions are itemized on the federal 1040 tax form, Schedule A. To calculate how non-taxable income (such as rent) equates to a taxable mortgage payment is difficult, as there are several tax implications to deal with. Keep in mind , though, that as the principal is paid down, equity builds up. This is kind of a forced savings, and if you add that portion to the tax savings, this would further reduce the rental equivalency.