How Interest Rates Work (Part 2)- Problems in the Mortgage Industry
by Carl Kiger, President of OakWealth Mortgage Group
The United States economy is truly a wonderful thing. Without too much government control or intervention, our economy grows and contracts based on the rules of supply and demand. You need only to look at the poor economic issues seen in other countries with too much government control to see the benefits of our “free market” economy. The recent issues in the mortgage industry have caused problems for the economy, and have also caused the federal government to look at greater intervention into the mortgage industry. If you have been watching the news media, you have probably heard discussions concerning the federal government stepping in to prevent lenders foreclosing on homeowners who are behind on their mortgages. While this may sound like great news to anyone who is in the foreclosure process, here is a brief description of why that would be negative for our overall economy.
Have you ever wondered why mortgage rates go up and down with the state of the economy, but credit card rates always tend to stay very high? Mortgage rates are tied to a tangible asset- your house. Lenders can loan money and provide a better interest rate because their risk is low. The money they are lending is tied to your house. If you ever stop making payments, they can recoup their money by selling your house. Inversely, the money loaned on credit cards is not tied to any tangible asset. Credit card issuers loan you money on your “good faith” promise to pay the money back. Although they can make your credit score look bad if you refuse to pay them, they cannot get their money back. Therefore, the risk that the credit card issuers take must be built into the rate they offer to consumers. This risk is why credit card rates are higher, and tend to stay high, even when other short-term rates drop.
With this information in mind, think what will happen if the federal government does not allow home mortgage lenders to foreclose on people who have stopped paying their mortgage. The lenders will not be able to recoup the money loaned out, and the mortgage industry will start taking on the look of the credit card industry. The risk the mortgage lenders are assuming will be much greater, and this risk will have to be built into the rates they offer to consumers. This would cause mortgage rates to be much higher on a permanent basis. Please do not get the impression that mortgage lenders are perfect. Over the last decade, there have been many predatory practices and high-risk lending practices that have contributed to the issues that we are currently facing in the mortgage industry.
While some additional government controls or laws may be needed to curb these practices, too much government control would cause more harm than benefit. Look at it this way: has the federal government ever run a program more efficiently than private industry can do? It may take over a year for our economic outlook to start improving; however, if we can make it through this downturn without breaking aspects of the economy which have worked well for decades, then I think we will all be better off in the long run.
To read Carl Kiger’s newsletter, OakWealth Viewpoint, click here.
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