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A quote from the Economist on 2023 September 7...

If you are American or Danish, the answer may well be that you have a fixed interest rate for the duration of your mortgage. As a result, you may pay as little attention as you wish to hawkish central bankers and climbing bond yields. In many other countries—including Britain, Canada and much of southern Europe—mortgage rates tend to be fixed for a few years at most, or not at all.

A re-financing is when the borrower chooses to end a previous mortgage loan and start a new one. The borrower might be motivated to re-finance because of a changed economic environment wherein interest rates have decreased such that that borrower can get a new rate that is lower than their previous rate. The Economist says there is a penalty for a re-finance in the U.S....

The catch is that you might want to repay your mortgage early—to move house, for instance. On a floating rate, the lender is unlikely to mind. After all, they are able to take your repayment and lend it to someone else for the same income. But on a fixed rate, they may mind considerably. Suppose you originally agreed to pay 5% interest for 30 years, then want to pay it back at a time when the equivalent market rate has fallen to 3%. In such a scenario, your lender will no longer be able to lend out your repayment for anything like the same income. Again, they will want compensation: the two-percentage-point difference, multiplied by the however-many years left on the mortgage, multiplied by your average remaining balance. A lot, in other words.

Here are some mortgage offerings in the U.S....

Rocket Mortgage...
30 year fixed, 20 year fixed.

Bank of America...
30 year fixed, 15 year fixed
5 year / 6 month ARM variable

Tyndall Federal Credit Union...
10 year, 15,year, 20 year, 30 year fixed
7 year adjustable

Here are some mortgage offerings in Canada...

Scotiabank...
3 year variable, 5 year variable
6 month, 1 year, 2 year, 3 year, 4 year, 5 year, 7 year, 10 year fixed

TD Canada Trust...
3 year fixed, 5 year fixed
5 year variable

Laurentian Bank...
3 year, 5 year, variable
6 month to 10 year fixed

Note that Canadian fixed rate mortgages tend to be less than 10 years and most fixed rate offerings in the U.S. are for more than 10 years. Why are long term fixed rate mortgages typical in the U.S.?

Some possible answers...

Could it be that Fannie Mae and Freddie Mac prefer to buy long duration assets? (That is, they incentivize the commercial banks to sell them such assets?)

Fannie and Freddie combine these assets and call them MBS (mortgage-backed securities) and sell them to investors. Could it be that these investors prefer long duration assets? I note that Blackrock iShares has 38 B USD in TLT (20+ years), 27 B USD in IEF (7 to 10 years) and 26 B USD in SHY (1 to 3 years) so when it comes to low risk assets, the ETF market suggests that although TLT is the biggest of the three funds there is substantial interest in shorter than 10 year assets. Those ETFs own U.S. Treasury bonds so it's not the same as Fannie's MBS issues but Fannie is a GSE (government-sponsored enterprise) so the comparison is relevant.

A U.S. commercial bank can still service the mortgage after it is sold to Fannie. Do the banks prefer 30 year contracts so that they can earn for servicing that contract for as long as possible?

Anecdotally, re-financing is commonplace in the U.S. when rates decrease so why isn't the penalty larger? TANSTAAFL! Could it be that the Economist is mistaken and there is no penalty?

The option to re-fi is an embedded option. The investor owns an asset and the borrower owns a call option on the asset. TANSTAAFL! Why do American borrowers want to pay for this call option? It is potentially a worthless option or diminished in value if there is a re-fi penalty.

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3 Answers 3

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The Economist is saying that if you want a fixed-rate loan which can be refinanced at no penalty, then you will initially have to pay a higher rate than for a loan which either has a variable rate or has a refinancing penalty, especially when prevailing rates are high and might fall in future. That is deemed acceptable in the US and Denmark but not elsewhere and has stuck for historical/political reasons.

In another recent article The Economist makes a distinct but related point: if in the US you want to move home, then you will have to give up your old low fixed-rate mortgage on your current home and get a new higher fixed-rate mortgage on your new home (essentially a forced refinancing in the wrong direction). This is discouraging moves and in the first quarter of 2023 housing transactions for existing homes were down by 22% on a year earlier. It points to Danish solutions to this, though notes there are also creditor-friendly rules on foreclosure and bankruptcy there.

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  • $\begingroup$ This doesn't even try to answer the question. The question is about the prevalence of long duration fixed rate in the U.S. versus short elsewhere. It does say that the U.S. market is "deemed acceptable" to the market participants but that's like stating the obvious. $\endgroup$
    – H2ONaCl
    Oct 8, 2023 at 6:44
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To answer the other sub-questions: in the US it is the borrower that desires the long dated mortgage, since it can take a long time to pay down the mortgage out of your income. Freddie and Fannie don’t care, since they generally don’t retain the mortgages. Shorter dated loans are also available for borrowers (15yr for example) but 30yr remains the most popular.

From the mortgage investor’s standpoint, the homeowner’s right to prepay is a major investment feature. Effectively the bond is like a callable bond, which is short convexity and therefore carries a higher coupon. In other words, the homeowner pays for the right to prepay through the higher coupon. It was my understanding that most mortgages do not carry a prepayment penalty, other than an administration fee.

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  • $\begingroup$ You said "right to prepay is a major investment feature". This sounds like vague marketing rhetoric. Are you saying it is a valuable option because most mortgages do not carry a prepayment penalty other than an administration fee? (This means the Economist is quite misleading about there being a hefty penalty.) $\endgroup$
    – H2ONaCl
    Oct 8, 2023 at 6:46
  • $\begingroup$ Your answer seems to be "it can take a long time to pay down the mortgage" in the U.S. without contrasting it with countries that use a shorter term fixed rate. The point of this question is contrasting countries in connection to long term fixed versus short. $\endgroup$
    – H2ONaCl
    Oct 8, 2023 at 8:54
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    $\begingroup$ On the second question, I believe that Canadian banks generally retain mortgages on balance sheet , which makes long dated fixed rate mortgages too risky. In the US, mortgages are generally securitized so this risk is passed to investors hence giving banks freedom to offer long dated fixed rate which is what the borrowers want. $\endgroup$
    – dm63
    Oct 8, 2023 at 15:51
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You may possibly want to read what Michael Lewis has written about tranches. Mortgage backed securities have not benefited housing consumers but have imposed costs on US citizens for the profit of Wall Street investors in these unregulated derivatives, such as the costs incurred in the housing crash in 2008-2009's great financial recession. Mortgages have different durations, the expected time until they are paid off which could be due to refinancing or else selling the home to move, or various other reasons like prepayment from inheritance or from earnings on other investments. Since the date is unknown, and investors do want to know the duration of the mortgages, the portfolios of mortgages are divided into tranches according to expected payment dates. So one tranche of the MBS will have a short duration while another will have a long duration, and investors can choose which they prefer. There had been efforts by investors to impose a requirement to hold a mortgage longer or to impose prepayment penalties but those were not well received in the US. The Big Short by Michael Lewis describes rating agency fraud, in rating tranches, that led to the housing crash and losses to many US citizens even while national wealth continued to grow overall. Liar's Poker is the history of mortgage backed securities from the 1970's preceding the 2008-2009 crash described in The Big Short. Mortgage backed securities are described today as "Bespoke Tranche Opportunities."

Now to answer to the question why are longer mortgage terms typical. There has been a long history of home mortgages in the US since the great depression. Originally people had to pay 50% down and only had 5 years to make payments, so few people could afford homes. The low down payments today and the long terms represents improvements over time which have allowed more people to buy homes (neglecting the widening wealth gap in the background of the same history). In general there are not large penalties for mortgage loan prepayment in the US, and also that low interest fixed rate mortgages do become valuable for the fixed rate and serve as disincentive to move or to sell a home. And when interest rates drop there is a rush to refinance at the lower fixed rate. Mortgage lenders may charge points upon the origination of a new loan if they believe the duration will be short, since they want the total interest to at least cover the expense involved in providing the loan agreement, or points may be charged to achieve a lower fixed interest rate such that someone expecting to keep a loan for many years will opt to pay the origination points, or the lenders may drop points when they believe a loan will last longer.

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