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Setting a Principal to Interest Cap on the Issuance of Home Mortgages: a Proposed Change to Mortgage Underwriting Rules Designed to Control Housing Price Inflation

Timothy A. Wunder

Abstract

Traditionally most home buyers in the US need a mortgage and the current system of mortgage origination creates an incentive for borrowers to offer bids on homes far higher than would be possible without that system. This has inflated home values, increased financial indebtedness, and has increased banking profits without extensively helping other players in the market. Over the past 50 years it has become easier to get a mortgage and it has become common for people to buy homes with little down and long repayment times. The result has been that for many borrowers almost all of the mortgage payment goes to pay for interest on the loan. In the 1950s, housing accounted for 22% of the household budget; that rose to 33% by 1980 and 43% today. The mortgage industry is supposed to help foster affordable home ownership yet, as currently instituted, it has resulted far greater expense leading to further hardships for those Americans with low incomes. This essay will explore how a rule to cap the principal to interest ratio in mortgage payments would impact the relevant institutions and offer an overview of how such a rule would guide society to a more socially desirable outcome.

Published on 2 Feb 2016 in World Economic Review No 6, February 2016 – Europe in Crisis