The History of Mortgage Banking in America

Mortgage banking in America has a rich and fascinating history that spans over two centuries. The first mortgage banks were established in the 1800s, with the first being the Bank of the Manhattan Company in 1799.

These early mortgage banks provided financing for the construction of homes and other buildings, marking the beginning of a long-standing tradition in American finance. The establishment of the Federal Reserve System in 1913 further solidified the role of mortgage banks in the US economy.

The 1930s saw significant changes in the mortgage banking industry with the introduction of the Federal Housing Administration (FHA) and the creation of the first mortgage-backed securities. This innovation enabled mortgage banks to package and sell mortgage loans to investors, expanding access to credit for homeowners.

Mortgages have been around for thousands of years, with references to them found among ancient civilizations.

The concept of a mortgage was first introduced into the American housing market in the 1930s, marking a significant shift from earlier money-lending practices.

Before the 1930s, US mortgage systems were quite different from what we know today, with residential mortgages typically lasting only 5 to 10 years and ending with large balloon payments.

These early mortgages were often characterized by bullet loans, variable interest rates, high down payments, and short loan terms, making it challenging for consumers to manage them.

Mortgage underwriting was heavily based on personal relationships and limited documentation, making lenders vulnerable to fraud and borrowers vulnerable to bias and discrimination.

Verification of income and employment was also inconsistent across institutions, adding to the risks associated with these early mortgages.

Mortgage lenders held significantly more power in the process than borrowers, with very low loan-to-value ratios of 50 percent or less, making them relatively low-risk investments.

The Great Depression in the early 1930s had a devastating impact on the US property market, with property values plummeting and many borrowers defaulting on their loans.

The surge in foreclosures between 1931 and 1935 was staggering, with about 250,000 occurring annually, and nearly 10% of all mortgaged homes were foreclosed at the height of the Great Depression.

In the 1930s, millions of Americans found themselves at risk of foreclosure due to plummeting home values and inability to make mortgage payments. President Franklin D. Roosevelt's New Deal programs, including the Home Owners' Loan Act, provided emergency relief for mortgage debt and introduced mortgage refinancing.

The Home Owners' Loan Act issued new mortgages with longer loan terms and lower interest rates, making payments more affordable for homeowners. This was a crucial step in stabilizing the housing market and preventing widespread foreclosure.

The New Deal also led to the creation of Fannie Mae, a reliable source of funding for housing that made affordable mortgage credit more accessible to families. The Federal Housing Administration (FHA) was created in 1934 to improve housing standards and provide access to affordable home financing, introducing lower down payment requirements and longer loan terms.

The Great Depression was a pivotal moment in American economic history, and its impact on mortgages was significant. The 1920s saw a surge in homeownership, fueled by affordable, interest-only mortgage payments that led to a housing bubble.

Many borrowers bought homes they couldn't afford, resulting in a high number of loan defaults. The growing mortgage debt, combined with plummeting home values, contributed to the bursting of the housing bubble and the stock market crash of 1929.

President Franklin D. Roosevelt's New Deal programs would later address some of the issues created by the Great Depression.

In 1933, President Franklin D. Roosevelt introduced The New Deal, a series of programs aimed at economic recovery and social reform. Millions of Americans were struggling to make mortgage payments, and banks were facing a difficult situation due to limited funds.

President Roosevelt's New Deal brought relief to homeowners through the Home Owners' Loan Act, which provided emergency mortgage debt relief and introduced mortgage refinancing. Homeowners were issued new mortgages with longer loan terms and lower interest rates.

The Home Owners' Loan Act was a crucial step towards stabilizing the mortgage market. Banks were able to offer more affordable mortgage payments, giving homeowners a chance to stay in their homes.

Just a few years later, the U.S. Congress created Fannie Mae, a subsect of the National Housing Act, to purchase FHA-backed mortgages and increase liquidity in the market. This move also introduced fixed-rate loan terms.

The creation of Fannie Mae was a significant step towards making affordable housing a reality for more Americans. With the introduction of fixed-rate loan terms, homeowners had more predictable mortgage payments.

The foreclosure crisis of 2007 was a wake-up call for lawmakers, who swiftly moved to ensure such a fiasco wouldn't happen again. The Dodd-Frank Wall Street Reform and Consumer Protection Act was born from calls for sweeping re-regulation of the financial system.

This landmark legislation, passed into law in 2010, rolled out in the form of regulatory pieces over the following five years, establishing numerous new mortgage regulations. The most critical ones include minimum standards for consumer mortgages, integrated consumer mortgage disclosures, loan originator compensation rules, and more stringent servicing rules.

Regulators, including the newly-formed Consumer Financial Protection Bureau (CFPB), introduced a host of new protections intended to produce financial stability and the safety of the consumer. The CFPB was made in charge of the Truth in Lending Act (TILA)’s Regulation Z (Reg Z), the Real Estate Settlement Procedures Act (RESPA)’s Regulation X (Reg X), and appraisal rules in FIRREA.

Reg Z set ability-to-repay (ATR) rules to require residential mortgage lenders to make a “reasonable and good faith effort to verify that the applicant is able to repay the loan.” This rule change aimed to prevent another foreclosure crisis like the one California faced in 2007.

The foreclosure crisis of 2007 left nearly 40% of California’s 6.5 million homeowners in a negative equity condition, with their houses worth far less than the remaining amounts owed on their mortgages. This led to the creation of the Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act), which established a uniform national licensing scheme for mortgage loan originators (MLOs) and the Nationwide Mortgage Licensing System and Registry (NMLS) for registering MLOs.

The SAFE Act aimed to prevent another foreclosure crisis by ensuring that mortgage loan originators are properly licensed and registered. California adopted its version of the SAFE Act in 2010, with the California Department of Real Estate (DRE) and the NMLS working together to implement it.

Here are the key mortgage regulations established by Dodd-Frank:

The Post-War Homeownership Boom was a remarkable period of growth in the US, with homeownership rates rising from 44% in 1940 to 62% by 1960. This significant increase was largely driven by the widespread adoption of long-term, fully amortized, low-down-payment mortgages.

Daniel Fetter, an economist at Stanford University, estimated that changes in home financing might explain about 40% of the overall increase in homeownership during this period. One of the primary pathways for the expansion of homeownership was the veterans' home loan program created under the 1944 Servicemen's Readjustment Act.

VA loans offered favorable terms, including repayment windows of 20 years and interest rates that could not exceed 4%. These loans were widely used, accounting for roughly 7.4% of the overall increase in homeownership between 1940 and 1960. Between 1949 and 1953, they averaged 24% of the market.

The demand for housing continued to grow as baby boomers entered adulthood in the 1970s and pursued homeownership. Congress responded by chartering a second Government-Sponsored Enterprise (GSE), the Federal Home Loan Mortgage Corporation, also known as Freddie Mac.