A 30-Year Trap: The Problem With America’s Weird Mortgages

Buying a home was hard before the pandemic. Somehow, it keeps getting harder.

Prices, already sky-high, have gotten even higher, up nearly 40 percent over the past three years. Available homes have gotten scarcer: Listings are down nearly 20 percent over the same period. And now interest rates have soared to a 20-year high, eroding buying power without — in defiance of normal economic logic — doing much to dent prices.

None of which, of course, is a problem for people who already own homes. They have been insulated from rising interest rates and, to a degree, from rising consumer prices. Their homes are worth more than ever. Their monthly housing costs are, for the most part, locked in place.

The reason for that divide — a big part of it, anyway — is a unique, ubiquitous feature of the U.S. housing market: the 30-year fixed-rate mortgage.

That mortgage has been so common for so long that it can be easy to forget how strange it is. Because the interest rate is fixed, homeowners get to freeze their monthly loan payments for as much as three decades, even if inflation picks up or interest rates rise. But because most U.S. mortgages can be paid off early with no penalty, homeowners can simply refinance if rates go down. Buyers get all of the benefits of a fixed rate, with none of the risks.

“It’s a one-sided bet,” said John Y. Campbell, a Harvard economist who has argued that the 30-year mortgage contributes to inequality. “If inflation goes way up, the lenders lose and the borrowers win. Whereas if inflation goes down, the borrower just refinances.”

This isn’t how things work elsewhere in the world. In Britain and Canada, among other places, interest rates are generally fixed for only a few years. That means the pain of higher rates is spread more evenly between buyers and existing owners.

In other countries, such as Germany, fixed-rate mortgages are common but borrowers can’t easily refinance. That means new buyers are dealing with higher borrowing costs, but so are longtime owners who bought when rates were higher. (Denmark has a system comparable to the United States’, but down payments are generally larger and lending standards stricter.)

Only the United States has such an extreme system of winners and losers, in which new buyers face borrowing costs of 7.5 percent or more while two-thirds of existing mortgage holders pay less than 4 percent. On a $400,000 home, that’s a difference of $1,000 in monthly housing costs.

“It’s a bifurcated market,” said Selma Hepp, chief economist at the real estate site CoreLogic. “It’s a market of haves and have-nots.”

It isn’t just that new buyers face higher interest rates than existing owners. It’s that the U.S. mortgage system is discouraging existing owners from putting their homes on the market — because if they move to another house, they’ll have to give up their low interest rates and get a much costlier mortgage. Many are choosing to stay put, deciding they can live without the extra bedroom or put up with the long commute a little while longer.

The result is a housing market that is frozen in place. With few homes on the market — and fewer still at prices that buyers can afford — sales of existing homes have fallen more than 15 percent in the past year, to their lowest level in over a decade. Many in the millennial generation, who were already struggling to break into the housing market, are finding they have to wait yet longer to buy their first homes.

“Affordability, no matter how you define it, is basically at its worst point since mortgage rates were in the teens” in the 1980s, said Richard K. Green, director of the Lusk Center for Real Estate at the University of Southern California. “We sort of implicitly give preference to incumbents over new people, and I don’t see any particular reason that should be the case.”

A ‘Historical Accident’

The story of the 30-year mortgage begins in the Great Depression. Many mortgages at the time had terms of 10 years or less and, unlike mortgages today, were not “self-amortizing” — meaning that rather than gradually paying down the loan’s principal along with the interest each month, borrowers owed the principal in full at the end of the term. In practice, that meant that borrowers would have to take out a new mortgage to pay off the old one.

That system worked until it didn’t: When the financial system seized up and home values collapsed, borrowers couldn’t roll over their loans. At one point in the early 1930s, nearly 10 percent of U.S. homes were in foreclosure, according to research by Mr. Green and a co-author, Susan M. Wachter of the University of Pennsylvania.

In response, the federal government created the Home Owners’ Loan Corporation, which used…