Prior to the 1930s, there was no mortgage market in the United States. Some insurance companies began offering contracts that helped people purchase homes, but their interest was in being able to take properties when people could no longer make the payments. Even with these contracts, most Americans were unable to buy a home because the upfront costs were too high. Often, buyers would have to pay as much as 80% of the home's total value as a down payment.
For those who could make the large down payment, the insurance companies then offered relatively short-term contracts (five to seven years) that were interest-only payments until a final balloon payment. So while few Americans could purchase a home under this system, those who did often defaulted on this final balloon payment, which led to high foreclosure rates.
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In 1934, in the middle of the Great Depression, the Federal Housing Administration (FHA) made some important changes to how people could buy a home that led to the modern mortgage system. One of the first changes the FHA made was to lower the down payment amount needed. So instead of having to pay 80% down, now buyers could get an 80% loan. The length of the purchase contracts was extended, letting people pay off their loans over fifteen years. The FHA system also introduced the amortization of loans, meaning that people paid interest and principal over time. This eliminated the interest-only/balloon payment structure of the earlier mortgage contracts.
The final major change the FHA made was to introduce loan standards. Whereas prior to the FHA program, loans would be made based on who knew whom, the FHA looked at whether a prospective buyer actually had the financial wherewithal to pay off the loan. As the FHA made these changes to the mortgage system, private commercial banks soon followed making buying a home more easily within the reach of the average American.
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