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Most US homebuyers who take out a mortgage choose a 30-year fixed rate option — but they may not realize how unusual this offer is.
“The 30-year fixed-rate mortgage is a uniquely American construct,” said Greg McBride, chief financial analyst at Bankrate.
True to its name, a 30-year fixed rate mortgage spreads the repayment over 30 years, with the interest rate remaining the same for the life of the loan.
As long as you don’t refinance or sell your home, the interest rate you get at the beginning of your mortgage won’t change, said Jacob Channel, senior economist at LendingTree. “You’re going to have the exact same interest rate regardless of what the broader market is doing,” Channel said.
In 2022, 89% of homebuyers applied for a 30-year mortgage, according to government data are analyzed from Homebuyer.com.
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The 30-year fixed-rate mortgage may exist in the U.S. because of the country’s deep financial markets, experts say.
“If we didn’t have the dominance of the fixed-rate mortgage in the U.S. residential mortgage market, we would see a much higher level of stress among existing homeowners,” McBride said.
The “whole reason” for the 30-year fixed rate mortgage
The secondary market for U.S. mortgage-backed securities is the “absolute reason” for the 30-year mortgage to exist, McBride explained.
About half of all U.S. mortgage loans will end up packaged into mortgage-backed securities and sold to bond investors, he said.
While mortgage-backed securities were at the center of the financial crisis and Great Recession, improvements have been made to avoid danger. Lenders, for example, have tightened their mortgage origination processes and improved underwriting standards and collateral evaluation, and there are now other guardrails that didn’t exist more than a decade ago.
Mortgage-backed securities are attractive to investors in the US and around the world because their government sponsorship makes them safe investments for long periods of time. They also provide a steady payout, said Daryl Fairweather, chief economist at Redfin, a real estate brokerage website.
The rate on 30-year fixed-rate mortgages tracks closely with 10-year Treasurys because “US real estate is almost as good an investment as a US Treasury bond,” he said.
But mortgage-backed securities are “only part of the story,” according to Enrique Martínez García, economic policy adviser at the Federal Reserve Bank of Dallas.
“There are two institutions in the US mortgage market that are very specific to the US: Fannie Mae and Freddie Mac,” said Martínez García.
The insurance provided by Fannie and Freddie is necessary because lenders are willing to take on the risk associated with interest rate changes, Martínez García explained.
“In most other countries, [that risk] it’s passed on to households, to buyers,” he said.
Even in countries where fixed-rate mortgages are prevalent, they usually cover shorter periods of time. That’s because such countries lack both the path to securitization and the institutions that take on the long-term risk, Martínez García said.
“This is what is missing in many other countries,” he said.
Foreign home buyers usually receive variable rates
While home buyers in other countries can usually get long-term mortgages or fixed-rate loans, the US is unusual in combining these features.
In Canada, for example, homeowners can get a mortgage that spans 25 years, but are expected to refinance every five years or so, Channel said.
In the UK, home owners can get fixed rate mortgages, but such loans only extend for up to five years.
“Every few years, you still do something that causes your rate to change,” Channel said.
The difference between fixed and variable rate mortgages lies in who bears the risk of interest rate fluctuations, Martínez García said. With fixed rate loans, financial institutions assume the risk. With variable rate loans, consumers do.