Prior to the Great Depression, there was almost no government involvement in residential mortgage lending. There was no federal deposit insurance or regulation. The home ownership rate was less than 50 percent in America. Down payment requirements of 50 percent were the norm. Most mortgage loans were short-term, sometimes as short as five years, and were set up as balloon mortgages. Many were interest-only loans.
In the beginning of the Depression, unlike today, the Fed actually CUT the money supply, raising interest rates and choking off investment. This made things worse, and the wave of foreclosures, notably farms, began rolling across the country.
According to a study at UC Berkely, when the Home Owner’s Loan Corporation (HOLC) was formed by the government and took over mortgages of those in distress (similar to today’s bailouts), “the HOLC refinanced the total amount due into a loan amortized for 15 years at 5% interest , compared to 6-7% interest rates available in the private sector, and the HOLC loan had no prepayment penalties. Borrowers were given the option to pay only interest for the first three years of the mortgage.”
While 7% doesn’t seem like an exceptionally high rate, keep in mind that at that point the US economy was actually experiencing deflation. Think of an equivalent being our economy at 4.2% inflation, as it was in 2008, and mortgage rates being over 12%!
The HOLC interest rate was eventually dropped further to 4.5%. Similar to today’s rates. Interestingly, after all the bailing out, HOLC managed to turn a profit in the end. Whether today’s efforts will be so rewarded is yet to be seen.
That Berkeley study is interesting. You can find it HERE