The Rise and Fall of the U.S. Mortgage and Credit ... - Milken Institute

An important contributing factor to the most recent credit boom and the record homeownership rate it
produced were the low interest rates that prevailed from 2001 to the end of 2004, as the Federal Reserve took
steps to combat the 2001 recession and prevent deflation.
Percent
12
10
8
6
4
2
0
Figure 4: Did the Fed lower interest rates too much and for too long?
Federal funds rate vs. rates on fixed and adjustable mortgages
30-year average
fixed mortgage rate
1-year adjustable
mortgage rate
Record low from June 25, 2003
to June 30, 2004: 1%
7
target federal
funds rate
Oct. 8, 2008: 1.5%
Oct. 29, 2008: 1%
1991 1993 1995 1997 1999 2001 2003 2005 2007
Sources: Freddie Mac, Federal Reserve, Milken Institute.
The low interest rate environment had another effect on many home buyers: they increasingly opted for
adjustable rate mortgages (ARMs) over fixed-rate mortgages (FRMs). ARMs held a clear attraction for lenders, as
they shifted interest rate risk to the borrowers. During the housing boom, many borrowers happily took that risk
in exchange for the low initial payments that made purchasing homes more affordable.
In addition to funding home purchases, mortgage loans can also allow borrowers to tap into any equity that is
built up in their homes. Indeed, nearly 15 percent of all mortgage originations in both 2006 and 2007 were home
equity loans, up sharply from only about 5 percent in 2001. During the housing boom, consumers increasingly
came to view their homes as ready sources of credit. In fact, some borrowers were using their home equity to
juggle debt or finance lifestyles they could not truly afford unless home prices kept rising.