Mortgages are an absurd financial anachronism. We need a better system.A young person recently asked me, “How do you buy a house?” I started in with the standard explanation. You save up for a down payment, blah, blah—then I realized I could answer this question from the bank’s point of view. Brace yourself, kid.
As a rule, every bank must keep 10% of its cash in an untouched reserve. It can loan out 90% of its balances. Thus, when a bank receives a deposit of $100,000 it can instantaneously create $100,000,000 in loans.
Where does the bank get the money to loan you? Often via an electronic transfer—most US dollars only exist electronically—from the Federal Reserve (despite the “Federal” in its name, it is a private bank that operates somewhat like a country club for other banks, giving them money from the US Treasury).
From the bank’s perspective, your 10% down payment IS the fractional reserve for your own loan. So when you put 10% down, you’re directly making it possible for the bank to access and issue the full amount of your loan because the 10% is the ONLY thing the bank needs to issue your debt—it’s the 10% reserve.
Of course the bank then charges you a lot of money for the loan that your deposit actually made possible.
If you can still find any true believers in the fundamental fairness of our current economic system, they might argue that the bank is justified in charging you so much over the life of your loan because it performs an important economic function in verifying your credit worthiness at the beginning. And, you know, sending you statements and stuff.
Decades ago, the work required of mortgage lenders might have been commensurate with what they earned in profit, but today? When the vast majority of US dollars exist electronically and can be moved around with ease? When your credit worthiness is a click away? When everything from your payment plan to your e-statement is automated?
How many total man hours do you think it takes for a bank to produce and service a mortgage today? Might those hours be paid for with a modest flat fee? Probably—but that would require dispelling the fiction that the bank is the wellspring of your loan.
A banker might interject here to say mortgage lending isn’t strictly about man hours. Their business is defined by opportunity cost—the cost of losing investment opportunities (in fossil fuels or pay-day lending perhaps) by choosing to invest in your mortgage (and the possibility of repossessing your property in the future after you’ve paid them for 10 or 20 years). They have to charge you so much, they argue, because if they didn’t loan you the money, they could be making profits with that capital.
When you realize that your down payment fully creates your loan, you know those arguments don’t carry any water.
We need a new 21st century model for mortgage lending. We also need to re-localize (either formally or informally through our choice of lender) the institutions that issue our mortgages—local lending institutions, credit unions, B corps and co-ops—who have an entirely different financial and philosophical (capital and social capital) orientation to opportunity cost. What is the real opportunity cost when local families can’t find affordable housing?
If we change how mortgage lending works, what will happen to the poor bankers? Clearly we’ll need to help them re-tool themselves for new, 21st century jobs. Perhaps they can learn to be mimes. After all, they’ve demonstrated an uncanny ability to create an invisible box. Or perhaps they can do what they so often ask of us: joyfully participate in their industry’s creative destruction.