Americans are buying their first home at an increasingly late age. In 2022, the typical first-time home buyer was 36 years old, and first-time buyers made up only 26 percent of total home purchases. These are the highest and lowest figures recorded in the history of this data, which started in 1981.
The reasons for this trend are familiar. Rising home prices and interest rates require larger down payments and mortgage payments. The federal government has a limited ability to increase the supply of housing, but it can do one simple thing to help buyers: First-time homebuyers should be eligible for a federally guaranteed, graduated-payment mortgage.
Suppose a prospective buyer aged 25-30 wishes to purchase a $420,000 home, which is close to the median home price in the United States. The typical mortgage guaranteed by the federal government — i.e., Fannie Mae and Freddie Mac —is a 30-year fixed rate mortgage. For first-time buyers, down payments are around 7 percent, and Fannie and Freddie will make loans with down payments as low as 3 percent.
Suppose the buyer makes a down payment of $20,000 and borrows $400,000. With current interest rates near 8 percent, the mortgage payment will be $2,935 a month. If the buyer plans to spend no more than 30 percent of their income on the mortgage, they will need income of at least $117,000 a year. In 2022, less than 35 percent of U.S. households had incomes this high.
A graduated-payment mortgage can substantially reduce a borrower’s initial mortgage payment. Suppose instead that the mortgage payment grows at 4 percent every year for the first 10 years and is constant thereafter. The initial mortgage payment will be $2,310, which is 21 percent lower than the constant-payment case.
Of course, the mortgage payment will grow over time, but it will take over six years to reach $2,935. At that point the homeowner could, if desired, always refinance into a fixed-payment mortgage to avoid further increases. Under a graduated-payment mortgage, the homeowner will build less initial equity in their home. The principal owed after 10 years will be about $350,000 for a constant-payment mortgage, but it will be $393,000 under a graduated-payment mortgage.
A graduated-payment mortgage can make sense for first-time homebuyers because most lifetime income growth occurs between ages 25-45. With a constant-payment mortgage, younger homebuyers are paying too much at the beginning of their mortgage, while older homeowners are paying too little at the end, relative to their lifetime income. A graduated-payment mortgage would better match household income and expenses over a lifetime.
A graduated-payment mortgage can be distinguished from the exotic mortgages that fueled the housing bubble of 2006-2008. First, graduated-payment mortgages have been successfully used by the Federal Housing Administration for years. Second, these mortgages would be offered by Fannie Mae and Freddie Mac, which could ensure they are affordable over the entire period of payment growth. The Fannie and Freddie guarantee would also ensure that financial institutions are willing to make these loans. Third, graduated-payment mortgages would only be available to borrowers who don’t currently own a home, so they would not flood the housing market with credit.
Young Americans increasingly need help to climb the first rung of the housing ladder. A graduated-payment mortgage is no solution to our housing crisis, but every little bit helps.
Prasad Krishnamurthy is a professor of law at U.C. Berkeley School of Law.