<p>SCG,</p>
<p>According to Tanta @ <a href="http://calculatedrisk.blogspot.com/2007/12/mud-luscious-balloons-for-ubernerds.html">CalculatedRisk</a> :</p>
<p><em>"In the very distant past (just before and during the Great Depression), most mortgage loans were balloons of this type or were interest-only loans with very short terms (a year was common). Why were IOs and balloons the only loans available back in the day? You have to remember that this was long before the invention of the ARM, or a mortgage loan that can “reprice” its interest rate to market without having to actually pay off an old loan and start a new one. Banks and thrifts that funded mortgage loans with deposits had the same problems back in the old days with interest rate risk that they have now: if you make a very long-term loan at a fixed rate of interest, you might find at some point before that loan pays off that prevailing interest rates paid on deposits have increased on you. You therefore have a loan out there earning you, say, 5%, and depositors expecting you to pay them 6%. That is called a “negative interest margin” or “the road to bank failure,” depending slightly on context. Even if you are not experiencing pressure on deposit rates, back in the thrift days of loans funded exclusively with deposits, you might find (It’s a Wonderful Life) that you just have all your assets tied up in slowly-repaying loans when your depositors want cash from you. That’s the classic “liquidity” problem. You will want to bear it in mind in any discussion of whether “the end of securitization” might come, or might be a bad or a good thing.
Offering only short-term loans that had to be renegotiated (refinanced) every year was a way to manage the asset-liability problem and keep things sufficiently liquid. It was, therefore, like the modern ARM, a form of risk-shifting: the interest rate and liquidity risk was taken off the banker and placed onto the borrower. It (more or less) kept the banks solvent and liquid, but it rather famously created a nasty trail of foreclosures when suddenly borrowers just couldn’t find a lender to renegotiate those maturing loans, and didn’t have the cash to pay them off. (Sound familiar? Yep.)
Without straying too far into the history of the mortgage in the U.S., suffice it to say that the big innovation coming out of the New Deal legislation that formed FHA and, subsequently, the old Federal National Mortgage Association (which turned into Fannie Mae, the GSE, rather later) was the fully-amortizing long term loan. At first the new thing was the 10-year loan, then the 20-year loan, then the 30-year loan. (Several decades later, you notice, we’re on the 40-year and even 50-year loan.) So this thing that Americans think of as the “traditional” 30-year fixed rate loan isn’t, in the big picture, all that old."</em></p>
<p>We chose a 30 year FRM based on stability, not emotion. We, as borrowers, have far more options than with any form of ARM. We can double up payments, we can (theoretically) withdraw equity, we can pay off at any time with no penalty, and the lender gets to do nothing but accept the pre-arranged payments. Compared that to a borrower with an ARM: they can choose their payments but eventually they have to pay more than that and little control over when those payments rise, their rate might reset lower but it can also reset much higher and they have NO control over which way it goes, their equity (based on their intial payments and the reset rate) can be unaccessable in the future due to income and interest rates on their ARM degrading their chances at another loan or HELOC. All of that sounds like a recipe for some extreme emotional distress in comparison with a boring 30-year fixed rate mortgage. Our was a practical decision, not an emotional one.</p>
<p>You're a mortgage broker, aren't you.</p>