Financial History Issue 113 (Spring 2015) | Page 12

EDUCATORS’ PERSPECTIVE

Financing the American Dream: A History of
the Fully-Amortized 30-Year Mortgage
A “dead pledge” sounds more like a
contract that Captain Jack Sparrow might
enter into than the typical American family. Yet for many who aspire to the American Dream of homeownership, that’s
exactly what they’re agreeing to when they
finance their homes with a mortgage. The
literal meaning of the term “mortgage,”
according to the Oxford English Dictionary, is “dead (from the Old French term
‘mort’) pledge (from the Old Germanic
term ‘gage’).” Today the American Dream
home is likely to be financed with a fullyamortized fixed-rate 30-year mortgage.
The astute reader will notice that the
term “mort” is also a component of the
word “amortize,” which literally means
“to death.” Is the American Dream of
homeownership a dream financed under
a double death threat? Fortunately, it’s not
as morbid as it seems.
According to The Word Detective,
“The logic of ‘mortgage’ is that of a ‘dead
pledge,’ meaning that if the borrower
repays the loan as agreed, the property
becomes ‘dead’ to the lender, who has no
further rights to it. And if the borrower
fails to pay, all of his or her rights to the
property cease.”1
To “amortize” a loan means to slowly
kill off the principal or amount borrowed.
With an amortized loan, part of each fixed
payment goes toward paying off the interest owed for the period of time since the
last loan payment. The remainder of the
payment goes towards paying off the principal. With a fully-amortized mortgage,
the entire principal is fully paid off when
the last payment is made and the borrower owes nothing more on the loan. The
fully-amortized mortgage is an innovative
financial instrument that came into common use during the Great Depression.
Real estate economists Richard K.
Green and Susan M. Wachter remind us
that “The US mortgage before the 1930s
would be nearly unrecognizable today.”

In spite of the increase in homeownerships during the 1920s, most families did
not own their own homes. Loan-to-value
ratios were typically 50% or less, meaning
that a down payment of at least 50% was
required to qualify for a mortgage.2
Many homeowners were unable to
save up for the hefty down payment and
financed it by taking out a second mortgage from a non-traditional lender, such
as the previous homeowner or a homebuilder, at a higher rate of interest than

Collection of the Museum of American Finance

By Dan Cooper and Brian Grinder

Specimen financial statement from the
Minnesota Building and Loan Association.

the first mortgage. Most mortgages were
of the interest-only variety,3 were financed
for short-term periods from five to 10 years
and required a balloon payment of the
remaining principal at the end of the loan’s
life. As a result, borrowers were constantly
refinancing or renegotiating the terms of

10    FINANCIAL HISTORY  |  Spring 2015  | www.MoAF.org

their loans, some on a yearly basis. These
types of loans worked well as long as house
prices remained stable or increased, but in
a market downturn, they spelled trouble.
“B&Ls [Building and Loan Associations],” writes economic historian Kenneth A. Snowden, “were the only lenders
to write amortized, long-term mortgages
in the late 19th century.” A B&L, according to Snowden, “was a small, local and
undiversified mutual fund into which
members contributed weekly or monthly
dues; the pooled dues were then lent to
members who chose to purchase…homes.
The interest payments and fees on these
loans, net of expenses and loan losses,
were returned to members as dividends.”
B&Ls were an important source of
mortgage loans in the 1920s.4 They used
what was known as the “Philadelphia
Plan” or share accumulation loan plan
to simulate an amortized mortgage.
Under this plan, the borrower obtained
an interest-only loan, often from a bank,
for less than 60% of the home’s value.
The B&L then required the borrower to
make monthly payments that were used
to purchase shares of the B&L. When the
value of the accumulating shares and the
dividends earned on those shares equaled
the loan’s principal, the mortgage was
paid off, and the homeowner was given
full title to the property.
A potential problem occurred if the
value of the shares fell because it forced
the borrower to make additional payments in order to pay off the principal.
B&L share prices dropped dramatically
during the Great Depression as house
prices also dropped. Many homeowners,
who were either unable to make their
interest payments or, worse yet, unable or
unwilling to refinance their loans, exacerbated the situation. Although financial
institutions displayed a great deal of forbearance,