Many people have variable rate mortgages, but the standard mortgage that most people try to get is a "30 year fixed", where the interest rate is locked for the entire 30 year term.

You pay a higher rate for a fixed than a variable, but you get a lot more certainty.

In Australia the amount you can overpay a fixed mortgage before you incur fees is relatively low. (Ie if you pay beyond an additional $20,000 per annum you start incurring fees.) Is it the same in the states?

Do people just pay the principal and interest for 30 years?

> Do people just pay the principal and interest for 30 years?

If interest rates go down, you refinance. If interest rates go up, you hold onto that cheap debt as long as you can. It’s a pretty unique product in that one party (the consumer) gets complete flexibility whereas the other (the bank) doesn’t

No, in general there is no prepayment penalty. In fact, it is relatively rare for a 30 year mortgage to last the entire 30 years. Normally it is paid off early, either because the person sells the home and moves somewhere else, meaning they pay off their old mortgage with the proceeds from the sale and get a new mortgage for the new house.

Or, you "refinance" your loan for a better interest rate after you have paid down the loan some. For example, I bought a house in 2018 and refinanced in 2020. Since my home price has gone up in those two years, and I had also paid some of the mortgage off, my rate was much better since my loan-to-value ratio was lower (basically the percentage of the market value of the home you are borrowing... the lower that is, the less risk the lender is taking, since they can sell the house to get back more than the cost of the loan, therefore it has a lower interest rate) I was able to save a large amount on my payment (went from paying $4700 a month to $3600), although it did extend the term of my loan for an extra two years. However, I doubt I'll be in the house that long anyway.

> No, in general there is no prepayment penalty. In fact, it is relatively rare for a 30 year mortgage to last the entire 30 years.

I believe the average mortgage duration is ~8 years, which is why the ‘mortgage rate’ tracks the 10 year Treasury rate and not the 30 year Treasury rate.

> In Australia the amount you can overpay a fixed mortgage before you incur fees is relatively low. (Ie if you pay beyond an additional $20,000 per annum you start incurring fees.) Is it the same in the states?

In several rounds of house buying and/or refinancing, I’ve never even seen an offer in the US that didn't expressly note the absence of an early payment penalty.

Except for certain very restricted circumstances, prepayment penalties have been illegal since 2014:

https://www.nolo.com/legal-encyclopedia/when-are-prepayment-...

No generally there is no pre-payment fee. Although I'm not going to say it doesn't exist. I've only heard about it on the internet. The avg length of stay in a house is like 4-5-6 years anyway at which point you request a payoff amount and the buyers money is sent to pay off the note. You can also pay any additional principal amount you'd like and pay it off in full at any time. You can also refinance it at any time if the rate drops.

So what do people in Australia do when they move and have to sell their house, which will happen a lot before the 30 years is up? Are the buyers stuck with the exact same terms that the original purchasers set on the remaining principal, and then have to enter a separate mortgage for the part that's already paid off?

Or do there tend to be clauses that allow full repayment on transfer of ownership or something like that?

We generally can't get fixed term mortgages that are greater than 3 years.

Most of us have variable mortgages with less conditions placed upon them.

In the US, the standard mortgage is 30 year fixed. i.e. you pay the same rate for 30 years. Adjustable rate mortgages exist, but are less typical.

That's pretty unique to the US, I think. Canada has no comparable product and the difference between "fixed" and "variable rate" mortgages here is that fixed mortgages are fixed for five years.

Adjustable rate mortgages (ARMs) weren't even available in the US until 1982, Congress didn't allow them. They're still around, the type you describe is a 5/1 ARM. Fixed rate for 5 years, adjusts every year after that. 3, 5, 7, and 10 year ARMs are common. A 5/1 loan rate is about 1% lower than a 30 year fixed now. It doesn't make much sense to me to take the risk with rates as low as they are now.

Those used to be much more common in the US. The 2008 housing crisis changed everything, and variable rate mortgages are extraordinarily rare now.

Interestingly, I never saw a fixed rate mortgage for 30 years in my country. The top fixation period is usually 10 years, anything higher than that is unusual.

A typical value is 5 years.

> Those used to be much more common in the US

Only briefly; the 30 year fixed has been a norm for a very long time, and the expansion of ARMs and more exotic creative financing instruments in the bubble leading up to the 2008 finance crises was itself a short-term aberration; there was also a brief run up in popularity when interest rates spiked in the 1980s (to avoid locking in sky-high rates.)

Main factor is that interest rates are so low (and have been for years now). With very low interest rates, it would be foolish to get an adjustable rate mortgage since it only has room to go up. Much better to lock in the very low rate for life. Thus, approximate nobody takes variable rate loans anymore.

When I first bought my house interest rates were over 7%, so getting discount on the interest in exchange of the risk of an adjustable rate mortgage made some sense.

Not unique, standard in several European countries I’ve lived in too

Surprising, that seems very inefficient. As a bank offering a mortgage I have to set an interest rate for entire period? Naturally I’m going to be conservative to ensure profit.. which hurts the consumer. Variable or short term fixed rates seems much more logical.

That's the point of securitization, which is the point of the article. The banks aren't holding the mortgage. They immediately sell it off to some other financial institution who wants to buy what basically amounts to a homeowner bond that pays the prevailing interest rate. (There are some differences mentioned elsewhere in this thread, notably that the homeowner has an option to pre-pay, there's collateral that the mortgage holder can foreclose on, risk profiles are different for homeowners than corporations, etc.)

The bank doesn't care what interest rates are going to be next year, because they sell the mortgage now and collect the cash for it. The buyer cares, but the buyer is probably a hedge, pension, or sovereign wealth fund that in theory at least should be able to estimate & offset interest rate risk.

I wish the article went into more detail about exactly who the losers are in this system. I suspect that it's essentially a policy by the U.S. government to increase social stability (in the form of homeownership, stable residence, investment in communities) at the expense of holders of U.S. dollars and dollar-denominated assets (i.e. most of the rest of the world). In other words, it's transferring wealth from non-citizens in exchange for keeping citizens happy, which is a pretty typical government play. It also looks like the system is on the verge of collapsing, in the sense that it pumps up house prices and encourages artificially low interest rates and high inflation, and hence an increasing number of American renters are being caught on the wrong side of the equation.

It's interesting you think there necessarily are "losers".

Interest rates are set in a competitive market. At any given point, there's a relatively fixed supply of money being put into what's on offer.

For buyers like pensions, it's simple: get the highest rate they can with acceptable risk and diversification. Keep in mind that not all of a fund's assets should be invested in super-long duration loans. Anyone running a fixed income portfolio understands this is a major source of risk (interest rate risk) as long-dated bonds are one of the most rate-sensitive investments possible. You'd do better with a blend of short, medium, and long-duration debt to ensure you don't end up hosed when rates move the wrong way.

Also keep in mind, many net buyers of this stuff are using it to offset long-term liabilities -- insurance loss payments, pensions, etc. Insurance companies will adjust premiums based on earnings of their investment portfolios.

And finally, keep in mind that interest rates aren't just a video game. There are major "real" drivers of them, economic growth being one--the demand for credit and its supply absolutely shifts over time, and throughout the business cycle. Real economic variables like demographics, home building, population shifts, the number of retired (more savings) vs working (more wage income) people in a population, etc. cause this stuff to move around a lot. If someone gets a higher rate, it's because at the time, there was more demand for credit, it wasn't just someone "losing" or getting "ripped off" that made that trade possible.

> The bank doesn't care what interest rates are going to be next year, because they sell the mortgage now and collect the cash for it. The buyer cares, but the buyer is probably a hedge, pension, or sovereign wealth fund that in theory at least should be able to estimate & offset interest rate risk.

One thing to note about securitization and prepenalties:

The risk of prepayment being priced in, but there is the opposite balance of the fact Mortgage Originators (not the borrower) in some circumstances do have a prepayment penalty; this period is typically up to 6 months after closing.

So, they care, but the risk is (like so many in finance) heavily abstracted.

>who the losers are in this system.

People who dont qualify. People who misuse it. As is the case with much debt, there is debt given to people who consume it, spend it, lose it and owe it; and there is debt given to people who invest it, accrue with it, and profit from it. Many people may stumble through the process and benefit from it, while the purchasing power of others who cant get it is diluted.

Patrick also links a good newsletter at the end that goes into the "who are the losers" question a bit: https://byrnehobart.medium.com/the-30-year-mortgage-is-an-in...

Interesting insights, my brain always goes to how to reduce inefficiency but there are many more things at play.

What percentages of conforming mortgages are sold off by the originators that wrote them, before the first payment is even due? If it is conforming, or close, there is almost no risk for the initial underwriter? I could be way off base, but that's mostly what the article is about, that the people offering loans arent the ones holding the risk.

Regarding risk for the initial underwriter, there are two main elements I think:

- fallout risk https://www.investopedia.com/terms/f/fallout-risk.asp

- pipeline risk: https://www.investopedia.com/terms/m/mortgage_pipeline.asp

For the fallout risk an originator can typically model the impact on the value of a mortgage with a conservative low digit basispoint estimate (following past fallout patterns that have been observed for example), for the pipeline risk the originator may do some more exotic price modelling by deriving implied interest rate volatilities from market prices (of interest rate derivatives).

Both risks are relatively speaking minimal given their short horizons and the (current) low volatility of interest rates.

I am impressed with the quality of the website linked to by the author of this thread, great read!

The website is of patio11 on hn

https://news.ycombinator.com/user?id=patio11

Many banks don't care, they are going to turn around and sell the loan. Some banks don't even make money off of the loan itself, they break even or even lose money originating the loan and make money servicing the loan - collecting the payments.

It's a trade, the consumer exchanges certainty about costs for a higher fixed rate than they'd get otherwise.

If the consumer doesn't like that they can get a lower cost variable rate mortgage just as easily.

Which is why .gov holds like 50% of residential mortgages. Any losses can be eaten by tax-paying renters [by virtue of government purse] to subsidize failures of homeowners/lenders. Home owners can watch their asset [privately] appreciate while failures in the mortgage system get socialized onto landless class as well.

Government technically isn't holding the mortgages - Fannie/Freddie/etc. buy the mortgage, repackage them into securities, and then sell the securities. The flow analogy in the article is really good - mortgages flow through a lot of intermediaries and get traded on markets. (The exception is the Fed's purchase of RMBS, which actually is a quasi-government agency holding mortgage assets. It's more like 25%, though; the Fed holds about $2.6T in RMBS, while the total RMBS market is about $10.3T.)

The socialization-of-losses aspect comes through interest rates. When wealth isn't held but is traded on markets, there's an incentive to hold interest rates artificially low, because that makes asset prices artificially high. High asset prices benefits all asset holders, so you can make people happier than they otherwise would be simply by keeping rates low.

During prior to the 2008 crisis, one of the shady practices was that all mortgage brokers, realtors and banks were pushing adjustable rates on everyone which was a huge reason so many people lost their homes.

Didn't interest rate plummet during that crisis?

Eventually... But we have to remember that things moved in waves.

2006/2007 was when the foreclosures started happening. Interest rates started going up in that timeframe [0], which lines up with the idea that folks couldn't refinance their ARMs into something they could keep paying on; first due to the higher interest rate, and second because the higher interest rate cause their house values to plummet. As these defaults piled up, in late 2007 and early 2008, the banks who later folded realized that their portfolios were not really salvageable.

[0] http://www.freddiemac.com/pmms/pmms30.html

I personally think they used this as one of the indicators of "sub-prime" because there were a TON of flippers in ~2004/05 (knew one guy who owned 40 houses with a group of 4 friends)

All APR to keep all the payments lower... they lost them all in 08/09.

That doesn't sound right. The rate is fixed till the renewable period, typically 5 or fewer years.

> That doesn't sound right.

It is.

> The rate is fixed till the renewable period, typically 5 or fewer years.

Lenders and mortgage brokers will often heavily push loans like that, ARMs with a short initial fixed period, using the (usually slightly) lower initial rate and the prospect of refi before the float as a hook, but full-term fixed-rate mortgages are still more popular.

Assertion requires evidence. This graph disagrees with you:

https://fred.stlouisfed.org/series/MORTGAGE30US

> This graph disagrees with you:

No, it doesn't. That's a chart of the average annual interest rate of 30 year mortgages, not the share of mortgages that are 30 year mortgages.

EDIT: The Mortgage Bankers Association does regular press releases of stats [0], and in them recently ARMs seem to be 3-3.5% of applications.

[0] e.g., https://www.mba.org/2022-press-releases/january/mortgage-app...

That is a chart of the interest rate of 30 year fixed rate mortgages in the United States.

What does that have to do with the ratio of fixed rate to adjustable rate mortgages?

That's the mortgage interest rate, not the percentage of 30-year fixed rate mortgages vs. ARM.

Categories > Money, Banking, & Finance > Interest Rates > Mortgage Rates

Unless you're not arguing against the last part of the parent comment...

Not in America. Here's a graph of the market share of 30-year fully fixed rate mortgages between 1996 and 2010: https://academic.oup.com/view-large/figure/114328487/hhu060f...

Point 2 is important for a bank if they hold the loan on their books. Normally, you as an individual don't worry about something being worth less unless you know you're going to sell it in the near future. You won't have a loss until you sell. Technically.

But for a bank, the government requires them to maintain a certain reserve amount. This is to handle withdrawals that are greater than planned.[0] The current loan value is an asset to the bank and so counts towards the reserve ratio. If the loan value drops, then they will have to sell some assets (probably some of those same loans) in order to raise some cash. Since they're forced to do this when it's disadvantageous to them, and it's likely that other banks are also trying to unload some loans to meet their reserve requirements, they have to offer those loans at a significant discount. Meaning they get even less for them than the low value they had them for.

[0] This is what killed Wachovia. There was a "silent" run on the bank over the weekend in 2008 by wealthy customers transferring out amounts above the then-FDIC insurance limit of $100k. It wiped out their reserves and the government forced a sale.

In America, the majority of loans (especially after 2008) are fixed interest rate for the life of the loan. So even if the FED/RBA raises the benchmark rate, the mortgage rate and the note associated with it will not change.