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In order to understand the theory behind the fixed rate mortgage, you have to understand the mindset of the mortgage banker and the mortgage borrower of thirty or forty years ago. The Great Depression left a tremendous impression on the minds of this country, so much so, that one of the popular mortgage products of the turn of the century, the interest only loan, was shelved, never to be heard from again. Not until the recent explosion in real estate prices and the mortgage industries efforts to accommodate home buyers of all types has there been such mortgage variety.

The trend after the depression, through post-war America, and really until the late 1990s was the fixed rate mortgage. That’s the type of mortgage the bank offered, and the public generally didn’t consider anything else. Why did so many individuals, as well as banking institutions popularize the fixed rate mortgage? This loan type, more than any other product available, was a security blanket for the banker, and the homeowner.

The banker, offering the mortgage loan, was assured of a 20% down payment and a secure monthly payment with a fixed interest rate that would benefit the bank. The homeowner received a set monthly payment amount that was affordable, and a fixed number of years to repay the loan, usually 20 or 30.

Since interest rates weren’t fluctuating then, as now, and real estate prices were fairly predictable, this was a win-win situation for everybody. Then came the extremely high interest rates of the 80s, and suddenly bankers were locked into mortgage with a fixed interest of only 7 or 8 percent. It is at this juncture that the lending institutions and the mortgage companies began to re-think the fixed rate mortgage. Maybe adjustable rate mortgages were better suited for such a fluctuating market; they could then reassess the interest rate if the rates skyrocketed. This wasn’t something the homeowner was in favor of using, but really what choice do you have? And usually, at some point, the rate will swing in the other direction. That’s exactly what happened during the late 90s and early part of 2000.

Since 2001, interest only loans, 125’s and ARMs have grown in popularity; on average, the interest only segment of the market is now around 30%. That’s an increase from 3% in 2001. The market has never before experienced the variety now available for mortgage products, but never before have we experienced the growth in real estate prices and lowered interest rates that we have seen in the last 5 years.

The beauty of all this growth, the fixed rate mortgage is like the little engine that could. It’s still around, still chugging up the hill, and still getting the job done. Statistically, many homeowners never payout their mortgage; they either sell their home or they refinance before the mortgage completes. This may be true, but for many of the homeowners I questioned, their home purchase was for the purpose of establishing a permanent residence, one in which to retire and live out their lives. That makes the good old standard 20 year Fixed Rate Mortgage look really good, even the 30 is still around (although not quite as appealing).

While there are places in this country that the real estate market has really boomed, and the real estate prices are soaring, there are still many that have not felt any effect, and for whom the appraisal prices of the 90s are still good today.

When you consider the trade-off for the adjusting interest rate, the flexibility of paying interest only, and the borrowing power of the 125, it’s hard to imagine that they are still homeowners who wish to use the fixed rate mortgage. That’s because, however you’re not looking at the entire picture. Many of these homeowners have experienced at least one job layoff.

Many of the baby boomers that bought houses 10 or 15 years ago were getting ready for retirement, and many of the homeowners live on fixed budgets. The purpose in purchasing a home for the vast majority of these homeowners was to provide for themselves a secure, paid for place to live. These homeowners aren’t interest in how to invest the equity of their home, nor are they interested in the other options they could exercise when investing their mortgage payment elsewhere. They’re simple interested in paying for their home, and the fixed rate mortgage is the slow and steady payment that will accomplish this task.

   Prior to the depression of the 1920s, there was a mortgage loan product used by many of the American people, known as the interest only loan. Why did this long disappear? And why has it suddenly reappeared? Let’s take a moment to answer each question, and hopefully provide some food for thought.

      During the 1920s and into the early 30s, many of the citizenry of this country chose to live above their means. They chose the interest only loan because it allowed them to purchase a larger home for less money. What happened when the stock market crashed and jobs were scarce, and there was no income? Many of these people were left without homes; as they had chosen to simply pay the interest on their mortgage there was no equity built into their homeownership. When no equity builds, and the income ceases, the bank forecloses and residents or forced from their homes.

      During the Great Depression this happen to many many homeowners. It was at this juncture that many landing institutions chose can remove this loan product from their offered products as it was simply too risky. But with the creation of the many mortgage products offered today, the interest only loan has made a return. And what a return!

      Today the interest only loan market segment comprises some 30% of the entire loan market; a development of only four years. Prior to 2001 days only loan market was a 3% segment of the entire market; the exponential growth we’ve experienced has set new records not only for the mortgage market, but for many financial markets in general. Add to this tremendous growth the also tremendous growth of the housing industry, and you have a very delicate situation.

      But does the interest only loan good for the average consumer? Not very much. There are individuals who truly benefit from an interest only loan, but they fall into a very small category. The greatest benefactors of interest only loan would-be investment individuals and young professional individuals who do not intend to retain their home for more than five years. How many of the actual mortgage applicants follow into this category? Less than 5%. So how do we have only 5% of the population that actually qualify for the interest only loan, and an interest only loan market of 30%?

      We have these conflicting figures because not everyone that purchases in interest only loan truly benefits from an interest only loan. The mortgage lender is not concerned with the benefit of the product to the purchaser. The mortgage lender is interested in the profitability of the product he or she has sold. And interest-only loan is a truly profitable product. In fact, the entire payment is a profit to the lending institution. Not one penny of the payment applies to principal for a specified term. Interest only payments, generally comprise only five to seven years of the entire term of the loan. After the initial five to seven year interest only term, the consumer begins to pay greater payments that apply to both principal and interest. As you can say this is truly not in the interest of the consumer, as most consumers do not begin to see a rise in income as quickly as they begin to see a rise in mortgage payment.

      Investors who have a trying staff of financial advisers and lending specialists truly understand how to use an interest only loan in order to turn a profit, but there is where an investor is not a homeowner. For homeowner has no interest in profitability, they are concerned with residency stability. They cannot afford to lose their home; an investor can afford to lose an investment. As you can see, there may have been merit and validity to the decision to remove interest only loans from their product offering during the 20s and 30s; it’s quite possible today, that we have lost sight of the devastation and destruction witnessed during the Great Depression. Let’s just hope the bubble doesn’t burst. Interest only loans are encouraging borrowers to live at the limits of their means, and I don’t think that’s good for the borrower, the economy or the housing market. What happens to the homeowner, should the bubble burst?