Mortgages and the Society: Are they any good?

“Mortgage Market refers to a conceptual construct where individuals, groups of individuals, and businesses source the money for their residential and commercial property needs”, says Campbell (2012, p 1). Therefore, the impact of mortgages on our society is profound. On one side, they enable social mobility by allowing people to become homeowners. Conversely, they create economic activity through spending on renovations, extensions, decoration, and construction. Therefore, increased activity in the mortgage market is bound to translate into increased activity in other sectors of the economy.

Mortgage Markets’ Positive implications on the society

The mortgage market enables a society in several ways. From helping people move onto the property ladder to increasing the wealth of nations. All these impacts are profound. However, a few concrete impacts of mortgage markets are as follows:

1. Help strengthen the local communities and house prices: When people choose to mortgage their homes in a particular area, it directly affects the prices of houses, business activity, and development of that area.
   1. Firstly, the increased availability of mortgages means that there’s a higher demand for houses. As a result, the value of the existing stock of assets goes up.
   1. Secondly, a new homebuyer generally spends considerable money on renovation and refurbishment of the house. Therefore, higher mortgage numbers mean people will spend money in the local community and help the local community to grow.
2. Increase social mobility: The ability of first-time buyers and less wealthy clients to get onto the property ladder strictly depends on the ease with which mortgages are available.
3. Improved Housing Quality: Increased home ownership due to mortgages ensures homeowners look after their houses. They are likely to spend on their maintenance and upgrade of the houses. This also results in increasing the energy efficiency of the house. However, the trend may be reversed during the economic downturn. As homeowners realise that banks may repurpose their houses, this could lower the efforts on maintaining the house.
4. Development of the Society by limiting the people’s ability to shift houses from one place to another. As mortgage holder become tied to their property, therefore, they would rather stay in the same place for longer. This helps a country to build local communities and promote social bonding.
5. The flow of capital from surplus agents to deficit agents enables banks to offer mortgages to people who do not have cash to buy a house.

Risks and Negative Implications of Mortgages:

Like other financial assets and markets, the mortgage market also has severe risks to the financial system and society.

1. Financial Crisis: As increased mortgage activity means rising housing prices, house prices may be inflated. This inflation eventually leads to a point where new buyers may end up paying exorbitant prices for the house. Therefore, when they borrow against the property, they must borrow huge sums and pay high interest on the principal amount. As a result, the risk of default increases. Imagine if 33% of your income is spent on a mortgage, then a slight reduction in your income may make default more likely.
2. Real Estate Bubbles: Increased activity in the mortgage activity means higher demand for the existing housing stocks. It also attracts the attention of speculators who want to get on the tide and make quick money. Therefore, people backed by purchasing power through loans offer higher and higher prices for the same asset. This entire activity results in a real estate pricing bubble and ultimately leads to large market corrections.
3. Volatility in Housing Prices: Similarly, when banks reduce the number of approved mortgage applications, it affects the house prices negatively. A decrease in the mortgage application approvals means that now there is a reduced demand (prospective buyers) in the market. This means that existing homeowners must lower the price to sell their houses. Therefore, mortgage markets play a great role in the ups and downs in the prices of houses and affect our personal portfolios.
4. Risk Aggressive Banking:  Banks are incentivised to issue mortgages to more and more people to earn a commission. Therefore, banks may lend money to people whose ability to pay back needs to be improved.
5. Consumer-oriented society: Another negative impact of mortgages is that they encourage consumerism and promote a society where individuals do not save enough.
6. Complex Securitisation: Banks employ financial engineering techniques to construct Mortgage-backed Securities (MBS). These securities go through a complex structuring process where assets with credit quality are combined to create tradeable financial instruments. These instruments are further sold to financial investors across the world. Therefore, mortgage holders’ performance (i.e., if they continue to pay on time and in full) results in an income stream for investors in faraway countries. Although this enables banks to generate higher income and distribute their risk across the market, nevertheless, it also creates systemic risk for financial markets and systems.
7. Default and Contagion: Complex securitisation distributes the default risk of counterparties system-wide and worldwide. Therefore, the performance of borrowers in one country determines the performance of portfolio holders in the other country. As a result, the entire financial markets become connected, and as one party defaults, it leads to the default of other parties.

References

1. Campbell, J. Y. (2013). Mortgage market design. Review of Finance, 17(1), 1-33.
2. Adelino, M., Schoar, A., & Severino, F. (2018). The role of housing and mortgage markets in the financial crisis. Annual Review of Financial Economics, 10, 25-41.
3. Chomsisengphet, S., & Pennington-Cross, A. (2006). The evolution of the subprime mortgage market. Federal Reserve Bank of St. Louis Review.
4. Cook, N., Smith, S. J., & Searle, B. A. (2009). Mortgage markets and cultures of consumption. Consumption, Markets and Culture, 12(2), 133-154.
5. Aalbers, M. B. (2016). The financialisation of home and the mortgage market crisis. In The financialisation of housing (pp. 40-63). Routledge.