Monday, October 12, 2015

A History of the Home Mortgage - Part #1 - Medieval Times to the Early 1900’s

The use of debt to facilitate the purchase of goods and services has occurred for more than 5000 years.  What most people think of when the hear the word “mortgage”, is a more recent form of property title secured loan used to fund the purchase of a home.  The amount of money required to buy a home today is very different than before there was such a thing as building codes, high quality housing design, municipal services, and home insurance. It would take many’s decades worth of saving disposable income to afford the purchase of a home outright. Now, we think of the market for mortgages and the willingness of lenders to provide financing for property ownership as constant and pervasive, but it hasn’t always been this way.  

Up until early in the 1900’s there was not a consistent and continuously available market for mortgages. The mortgages that happened to be available were short term in nature, often requiring all of the principal amount to be paid at the end of one year, along with a equivalent interest rate above 20% to 30% per annum.  We wanted to find out about the origin of mortgages and understand the evolution of mortgage law up to and beyond the turn of the 20th century, as well as understand the biggest shifts in the mortgage market during the last 100 years. We will also look at how the mortgage markets went from being spotty, unregulated, and uncertain, to become one of the most sophisticated and largest financial markets in the world. Although the ability for the majority of people in North America to obtain a mortgage has improved, there is still much room to grow and expand mortgage finance. New mortgage options have the ability to accelerate economic development and open up home ownership as a universal choice. Read on to find out more.

In medieval England, up until the 16th century all “mortgage’ contracts actually provided the lender control of title (rather than the borrower). Charging interest was considered “usurious” (sinful) and therefore illegal up to that point in time.  Instead, the “lender” would charge rent and participate in profits generated from the land by virtue of holding title. When the required payments were made to satisfy the mortgage contract, control of title would pass free and clear to the borrower.  This form or mortgage tended to result in many more cases of the borrower losing the property, with the lender forcing the borrower off and permanently keeping ownership along with all profits from that day forward.

Prior to the introduction of the “equity of redemption” law in the 17th century, borrowers had few rights and would easily lose their entire economic interest in a property. They needed to not only satisfy the repayment of the terms under the mortgage agreement but were also required to produce written proof confirming the same. They needed this additional documentation to defend themselves in court if a lender tried to argue they had failed to satisfy the agreement while intending to take full ownership for themselves without having to pay the borrower any more for it.

With the advance of the “equity of redemption” right, borrowers could then regain their property by making the required outstanding payment of principal and interest within a period of time after the repayment date stipulated on the mortgage contract.  In addition, if the full amount wasn’t paid on time, the lender was required to keep a strict accounting of the rents or profits received and once enough had been collected to cover the deficit the property had to be transferred back to the borrower. The right of redemption period could be as long as 20 years, or the lender could apply to the court for a final end to this period which became known as “foreclosure”. By way of comparison, over the last 100 years, the right of redemption for most States in the US has dropped down to 3 or 4 months or less.  In Canada, there is a 6 month right of redemption period which applies unless the lender proves there is no equity in the property and their principal balance is at risk.

Through out the 1800’s the lending markets for mortgages were not nationally organized.  Mortgage contracts and the ownership of land largely revolved around farming and food production as well as urban housing development. 

Prior to the creation of Central Banks in the US and Canada during 1913 and 1935 respectively, mortgage markets were largely funded by life insurance companies, regional trusts, mortgage companies, as well as individual lenders. And especially prior to the 1900’s in the US, as national banks were prohibited entirely from lending in the farm mortgage market

In the late 1890’s, mortgage banks could fund their lending activities by issuing debentures against pools of mortgages.  There was a crises that ensued following several years of drought when a wave of farm mortgage defaults began. Evidence was later found showing mortgage companies had placed lower quality loans behind the debentures that had been sold to investors. It seems history clearly repeated itself when during 2008 the great recession started based on loans that were provided to people who could not have afforded the payments and were a key part of the sub-prime mortgage securitization industry. 

In the US, beginning with a nationwide trend moving to single family home ownership starting early in the 1900’s and following the Great Depression, the banks finally began to enter the mortgage market with concerted effort. It took the governments of both the US and Canada to create housing loan insurance programs to allow the banks to get comfortable carrying long term fixed rate mortgage debt on their balance sheets. With the advent of these new mortgage insurance plans the banks volume of home loans grew to become the majority of the market within two decades. It took both a great war and a depression to put these wheels in motion but both Canada and the US decided that home ownership and the construction of housing was an important part of the economy. This improved activity in the mortgage markets helped fulfil the popular dream of owning a home in North America.

Coming soon in the next part of this series, we will look at how the markets evolved from the early 1900’s around the time the banks entered the scene, to what happened leading up the credit crisis of 2008.

Mortgage Banking in the United States, 1870–1940 Research Institute for Housing America.

The Historical Origins of America’s Mortgage Laws, Research Institute for Housing America.