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Why a 30-Year Fixed-Rate Mortgage Could Be a "Dangerous" Investment

In late 2009, a Wall Street Journal reporter wrote that "questioning the sanctity of the 30-year fixed home loan is tantamount to proposing that the White House should be repainted pink."

With mortgage rates near historic lows, buyers may be tempted to lock in that long-term certainty. It's not difficult to see why the 30-year rate is so appealing: loans 30 years in length, with a fixed interest rate. Typically, the home-buying borrower will put roughly 20% down and then borrow the remaining 80% from a financial institution (the average down payment on all mortgages has been around 25% of late, a 20-year high).

But the popularity of the 30-year fixed mortgage could be a bad thing, Robert Shiller told me recently in an interview in front of a live audience at Motley Fool Headquarters.

Shiller, a Yale professor who just published his 10th book, Finance and the Good Society, is a leading expert on housing; in the video below, see why he thinks these types of mortgages represent "conventional thinking," a pet peeve of his. (Run time is 1:16; a transcript is below.)

Brian Richards: I read in an interview that you did that your biggest pet peeve was conventional thinking.

Robert Shiller: Right, that's a chapter in this book.

Richards: Could you give us an example in finance or investing, in a financial or a business context, where you see too much conventional thinking?

Shiller: Well, I'm thinking in terms of mortgages -- that most people will buy a house and borrow 90% of the money in a fixed-rate, 30-year mortgage, and that puts them in a leveraged position.

For some reason, that's conventional. And people have been trying to propose alternatives like shared-appreciation mortgages, or what I described in here [Finance and the Good Society] as a "continuous workout mortgage." That would be risk-managing. To me, the leveraged investments -- undiversified investments -- are dangerous, and we've seen what happened with the current financial crisis. And yet, nothing fundamental has changed.

So Dodd-Frank calls for a study of shared-appreciation mortgages, but we haven't seen it yet. Nothing, we're just doing the same; Fannie and Freddie have failed. They're now taken under the government and they're just doing the same thing. I think people are just very mistrustful.

For more insights from my talk with Robert Shiller, see:

Brian Richards is the managing editor of Fool.com. Follow Brian on Twitter: @brianlrichards.


Read/Post Comments (8) | Recommend This Article (13)

Comments from our Foolish Readers

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  • Report this Comment On April 13, 2012, at 5:44 PM, jssiegel wrote:

    shared-appreciation mortgage?

    continuous workout mortgage?

    Nothing found on a search of Fool other than this article. I'm *very* skeptical of any sort of exotic mortgage, especially when the rate on 30-year fixed is around 4% and I can get about 6% on a pretty conservative investment.

  • Report this Comment On April 13, 2012, at 6:15 PM, showme wrote:

    I think Mr. Shiller is confusing a 30 year fixed with a 1, 5 or 15 year adjustable. The dramatic decrease in property value was devastating, but when combined with a sky rocketing interest payment almost no one can survive that. At this time most home buyers do not have access to even a boring conventional 30 year fixed with less than 20% down and stellar credit. The strategy of leverage to the common home buyer is a thing of the past but I am in total agreement, nothing has changed for the real estate investment banking industry, but "shared-appreciation mortgage" and "continuous workout mortgage" now that sounds like credit default swap language if I ever heard it.

  • Report this Comment On April 13, 2012, at 8:06 PM, joelrwhite wrote:

    According to Wikipedia, "A shared appreciation mortgage is a mortgage in which the lender agrees to an interest rate lower than the prevailing market rate, in exchange for a share of the appreciated value of the collateral property."

    And in another article by Robert Shiller in the NY Times in 2008, he wrote, "We need to innovate, with the creation of “continuous-workout mortgages.” Such mortgage contracts, when originally signed, would specify a program for steady adjustment of the balance and payment schedule over the life of the mortgage, enabling most homeowners to continue to afford to make payments and maintain some home equity, even in harsh economic circumstances."

    The former gives the banks a share of the profit upon sale of the home and the latter sounds like an automatic loan modification. Not sure which one would be better, if any are better versus a fixed 30yr.

  • Report this Comment On April 14, 2012, at 8:37 PM, ayalara wrote:

    What a misleading title for an article. I thought I just might find out "why ..." by reading it but was greatly disappointed.

  • Report this Comment On April 14, 2012, at 9:19 PM, Estrogen wrote:

    for most places in the country, a 30 year note is cheaper than rent, if one puts down 20% and avoids PMI.

    When one factors in tax benefits, minus property tax and maintenance, I believe one is way ahead in long run.

    The problem is most americans "consume" their house during times of inflation, and when homes come back to earth and the economy tanks....the rest is history...

  • Report this Comment On April 15, 2012, at 3:54 AM, memoandstitch wrote:

    @joelrwhite

    According to econ 102, in an ideal world, every contract covers all possible contingencies. Shiller just wants an ideal world.

  • Report this Comment On April 15, 2012, at 9:04 AM, jfrankh57 wrote:

    30 year fixed means you have a set situation. You KNOW what is going to happen for the next 30 years. You will have that SET amount debt payment every month. The only down side is you might buy in a bubble such as happened over the past 10-12 years and pay MORE than something is worth. I kept shaking my head at the meteoric rise in housing costs during those years and could not understand how so many people could/would afford such stupid inflation. I was quite happy sitting in my little house, I paid $81000 for in 1998 and thought even that was too much, yet I am happy since the downturn hasn't put me under water with my 30 year mortgage...I will be able to afford my house and continue to pay it down. Had I not been "figuratively" robbed by the massive downturn in the economy/market 2006-2009, I would have the puppy paid off now. But that STRUCTURED payment is GREAT for the average buyer who can't plunk 30-40-50% or more down on a house, especially the first time!

  • Report this Comment On April 16, 2012, at 11:24 AM, jpanspac wrote:

    I don't see anything wrong with conventional thinking. It was "financial innovation" that put us in the mess we're in.

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