Interesting Interest

I asked a broker friend what he thought my topic should be for this day, and he suggested that I should re-visit the extreme home loan rates of the 1980’s and 1990’s. I remember those days, so I got excited about the suggestion and here we are.

Interest rates of 20% or more sounds crazy today, but there was a time when it was reality, and we all took notice when someone found a home loan at only 18%. In a nutshell, the cause of such high interest rates was the Fed’s response to mounting inflationary pressures through the 70’s and 80’s. It kept raising the rates at which banks could borrow money, which trickled down to consumer-oriented loan rates.

The economy was not as global then. A global economy tends to keep a lid on prices because there is always someone willing to do the job or make the gizmo for less, somewhere on the planet. A more insular economy means that prices respond to internal national pressures for higher wages and more expensive products. Rising prices mean inflation. The way the Fed cooled down rising prices in the 80’s was to put a lid on the economy through making the cost of borrowing money to do business higher.

We haven’t seen the super-high interest rates in decades because, due to the different structure of the economy now, inflation hasn’t been much of a threat.

I found one blog associated with a commercial website that did a great job of explaining the 20th Century history of home loans.

In the early 1900’s, a typical loan structure was 50% down, and a 3-5 year payment on interest only followed by the entire principal due at the end of that time. Needless to say, you had to be pretty wealthy to afford a home.

summer home in walpole
Circa 1915. You needed a lot of cash to build this home!

In the 30’s, because of the Great Depression, there wasn’t much money to loan and not very many people could afford a home loan anyway. The federal government decided that more people should be able to buy homes and that this was a good way to promote the health and welfare of families, thereby promoting the health and welfare of the nation. The government gave birth to the Federal Housing Administration, which gave birth to 30-year mortgages and amortization.

Freese ranch house being built.
Home under construction in about 1940. A home loan was entirely possible by then.

The great story of mortgages and increase in homeownership in the U.S. goes on through the 70’s, 80’s, and 90’s in which the government and private institutions invented more ways to make money available to those institutions to lend to consumers. There have been perilous instruments such as ARMS and wraparound loans and subprime mortgages that helped some consumers get and keep the homes of their dreams, but created nightmares for many others who defaulted on their loans.

In times of high inflation, it makes sense to borrow money, even at a high rate of interest, to buy the most expensive house you can because the money you are using to pay back the loan is worth less and less as inflation rises. With the relatively flat rate of inflation we’ve been experiencing for some time, this strategy makes no sense, since you are paying back money that is worth about the same as the money you borrowed in the first place.

So, what’s with our gently rising interest rates now? Compared to the past, the current home loan rates of approximately 4 to 4.25% still seems pretty small, don’t they?

Here are a few more websites that are themselves a few years old that I found helpful in explaining the 1980’s that I still remember.

And, I can’t recommend enough this easy read on the modern history of home loans:

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