How the 30-Year Fixed-Rate Mortgage Can Backfire

Join the Fool for a talk with Chris Mayer, who is the Paul Milstein Professor of Real Estate at Columbia Business School. Mayer is also a visiting scholar at the Federal Reserve Bank of New York, and the co-director of the Richard Paul Richman Center for Business, Law, and Public Policy. His research has delved into topics such as housing cycles, mortgage markets, debt securitization, and commercial real estate valuation.

Plenty of countries have high homeownership rates without 30-year fixed-rate mortgages. Should the U.S. follow suit? In the following video, Mayer explains his views on ARMs and 30-year fixed mortgages, as well as the Canadian market and where it may be headed.

Full transcript below.

David Hanson: One of the things that, when they're talking about GSE reform, they say, "We've got to keep the 30-year fixed. That's crucial to the economy and crucial to the housing market." But if we look outside the U.S., there are countries with higher homeownership rates. Do we need the 30-year fixed mortgage?

Chris Mayer: You are completely correct. If you look globally, very few countries have a 30-year fixed-rate mortgage. Many countries have homeownership rates higher than the U.S.

Do we need it? No. Is it a psychological issue for many Americans? It is, and I think that is showing up in the political process in a way that is going to make it very likely that the 30-year fixed rate is going to stay.

But as an economist, I've actually written a paper, for example, talking about why prepayment penalties can actually be a good thing. I think this crisis has shown us that the 30-year fixed-rate mortgage is really good for people who are well qualified, have lots of money, and when interest rates fall they're always going to be able to refinance.

If you're a distressed borrower, and watched your home go down in value, there were tens of millions of Americans who could never access lower interest rates to refinance, so if you ask, "Who got the best deal through the crisis on interest rates?" it was people who had ARMs.

At the end of the day, what do I advise people? I think an ARM is a good product, and I also think that if we're going to go through this with the 30-year fixed, we have to figure out a way to help people, particularly distressed borrowers, refinance if we're going to have the risk of another crisis.

Hanson: Right. Staying abroad, there's been some talks about Canada, Australia, that their housing markets look a lot like ours did, back in 2006.

Mayer: Yes.

Hanson: Have you looked at those markets at all, and do you think that there's potential looming there in the real estate in the banking industry?

Mayer: I'll give you an anecdote. I traveled to Canada last summer. I've spent a bunch of time traveling different parts of the world, so -- when you ask about global stuff -- I've become very interested in learning about what other people do, because I think that's really important.

I was traveling last summer to the University of British Columbia to give a talk, and I'm going through customs. The customs officer says, "What are you doing in the country?"

"I'm going to the University of British Columbia."

"What, are you a professor? What are you going to talk on?"

"I'm going to talk on the housing market."

He looks at me and says, "Do we have a housing bubble here in Vancouver?"

It reminded me: The last time somebody asked me that question was a CNBC cameraman in 2005, who was telling me about the third home that he was about to purchase. It had a little bit of that feel. There's always this ... when people are really nervous about a bubble, there's probably at least something there. Not when it's economists; when it's ordinary people.

I think there are a lot of people who are worried about Canada right now, and I think also Australia has people who are concerned about the level of house prices.

In fact, unlike the previous time, when people didn't take into account housing in the banks, you've seen some of the Canadian banks get downgraded, for example, because of concerns about risk in the housing sector.

I do think that there's concern there. I'm not close enough to it to say, "Yes, the bubble's going to crash on this date," but there are enough signs out there that people certainly have to be aware of those issues.