Chester Madej, president of Siara Management Ltd., stands outside the North Church Towers apartments in Parma Heights, Ohio Thursday, March 27, 2003. Madej, whose company manages this complex and 10 others in Ohio, l ‘Indiana, New York and Pennsylvania said they were having trouble finding reliable tenants because low mortgage interest rates make it hard to pass up homeownership. Photo: Mark Duncan/AP

The average interest rate on a new 30-year fixed-rate mortgage in the United States exceeded 7% at the end of October 2022 for the first time in more than two decades. This is a sharp increase from the previous year, when lenders only charged buyers 3.09% for the same type of loan.

Several factors, including inflation rates and the general economic outlook, affect mortgage rates. A key driver of the ongoing upward spiral is the Federal Reserve’s series of interest rate hikes aimed at controlling inflation. Its decision to increase the benchmark rate by 0.75 percentage points on November 2, 2022, to 4%, will push the cost of mortgages even higher.

Even if you’ve had mortgage debt for years, you might not know the history of those loans — a topic I cover in my course on Mortgage Financing for Undergraduate Business Students at Mississippi State. University.

The term dates back to medieval England. But the roots of these legal contracts, in which land is pledged for a debt and will become the property of the lender if the loan is not repaid, go back thousands of years.

ancient roots

Historians trace the origins of mortgage contracts to the reign of King Artaxerxes of Persia, who ruled modern Iran in the 5th century BC. The Roman Empire formalized and documented the legal process of pledging a loan.

Often using the forum and temples as a base of operations, mensarii, which is derived from the word mensa or “bank” in Latin, arranged loans and charged borrowers interest. These government-appointed public bankers required the borrower to provide collateral, whether real estate or personal property, and their agreement to the use of collateral would be handled in three ways.

First, the Fiducia, Latin for “trust” or “confidence”, required the transfer of ownership and possession to the lenders until the debt was paid in full. Ironically, this arrangement did not imply any trust.

Second, the Pignus, Latin for “pawn”, allowed borrowers to retain ownership while sacrificing possession and use until they repaid their debts.

Finally, the Hypotheca, Latin for “pledge,” allows borrowers to retain both property and possession while paying off their debts.

20-year mortgage rates.

The commitment of the living against the dead

Emperor Claudius introduced Roman law and customs to Britain in AD 43. During the next four centuries of Roman rule and the next 600 years known as the Dark Ages, the British adopted another Latin term for a pledge of security or guarantee for loans: Vadium.

If pledged as collateral for a loan, real estate may be offered as “Vivum Vadium”. The literal translation of this term is “living commitment”. The land would be temporarily pledged to the lender who used it to generate income to repay the debt. Once the lender collected enough revenue to cover the debt and some interest, the land reverted to the borrower.

With the alternative, the “Mortuum Vadium” or “death pledge”, the land was pledged to the lender until the borrower could repay the debt in full. It was essentially an interest-only loan with full principal payment by the borrower required at a later date. When the lender demanded repayment, the borrower had to repay the loan or lose the land.

Lenders would keep the proceeds of the land, whether it was income from farming, selling timber, or renting the property for housing. In effect, the land was dead to the debtor during the term of the loan as it provided no benefit to the borrower.

After William the Conqueror’s victory at the Battle of Hastings in 1066, the English language was heavily influenced by Norman French – the language of William.

This is how the Latin term “Mortuum Vadium” turned into “Mort Gage”, the Norman French meaning “death” and “gage”. “Mortgage”, a mixture of the two words, then entered the English vocabulary.

Constitution of borrowers’ rights

Unlike today’s mortgages, which are usually due within 15 or 30 years, English loans of the 11th-16th centuries were unpredictable. Lenders could demand repayment at any time. If the borrowers could not comply, the lenders could seek a court order and the land would be forfeited by the borrower to the lender.

Disgruntled borrowers could petition the king regarding their predicament. He could refer the matter to the Lord Chancellor, who could decide as he saw fit.

Sir Francis Bacon, Lord Chancellor of England from 1618 to 1621, established the equitable right of redemption.

This new right allowed borrowers to repay their debts, even after default.

The official end of the period to redeem the property was called the foreclosure, which is derived from an old French word meaning “to exclude”. Today, foreclosure is a legal process in which lenders take possession of property used as collateral for a loan.

Early history of housing in the United States

English colonization of what is now the United States did not immediately transplant mortgages across the pond.

But eventually, American financial institutions offered mortgages.

Prior to 1930, they were modest – typically amounting to no more than half of a home’s market value.

These loans were generally short-term, maturing in less than 10 years, with repayments due only twice a year. Borrowers either paid nothing of the principal or made a few such payments before the due date.

Borrowers would have to refinance loans if they couldn’t repay them.

Daoud Othman stands outside the house he is buying in Clifton, New Jersey, Friday July 11, 2003. Othman, 39, a devout Palestinian Muslim who came to the United States 14 years before this picture, does not would not apply for a conventional mortgage because of a prohibition in the Koran to pay interest.
Photo: Mike Deer/AP

Save the housing market

Once America fell into the Great Depression, the banking system collapsed.

With most homeowners unable to pay off or refinance their mortgages, the housing market collapsed. The number of foreclosures rose to over 1,000 a day in 1933 and housing prices fell precipitously.

The federal government responded by creating new agencies to stabilize the housing market.

They included the Federal Housing Administration. It provides mortgage insurance – borrowers pay a small fee to protect lenders in the event of default.

Another new agency, the Home Owners’ Loan Corp., established in 1933, bought short-term, semi-annual, interest-only mortgages and turned them into new long-term loans with 15-year terms.

Payments were monthly and self-amortized – covering both principal and interest. They were also fixed rate, remaining stable for the duration of the mortgage. Initially they were more interest oriented and later they disbursed more principal. The company made new loans for three years, doing so until it closed in 1951. It pioneered long-term mortgages in the United States.

In 1938, Congress created the Federal National Mortgage Association, better known as Fannie Mae. This government-sponsored company made long-term, fixed-rate mortgages viable through a process called securitization — by selling debt to investors and using the proceeds to buy those long-term mortgages from banks. This process reduced risk for banks and encouraged long-term mortgage lending.

Fixed-rate or adjustable-rate mortgages

After World War II, Congress authorized the Federal Housing Administration to insure 30-year loans for new construction and, a few years later, purchases of existing homes. But then the credit crisis of 1966 and the years of high inflation that followed made variable rate mortgages more popular.

Known as ARMs, these mortgages have stable rates for only a few years. Typically, the initial rate is significantly lower than it would be for 15 or 30 year fixed rate mortgages. After this initial period is over, interest rates on ARMs are adjusted up or down each year, along with monthly payments to lenders.

Unlike the rest of the world, where ARMs prevail, Americans still prefer the 30-year fixed rate mortgage.

About 61% of American homeowners have mortgages today – with fixed rates the dominant type.

But as interest rates rise, the demand for ARM increases again. If the Federal Reserve fails to curb inflation and interest rates continue to climb, unfortunately for some ARM borrowers, the term “death pledge” may live up to its name.

Michael J. Highfield is Professor of Finance and Warren Chair of Real Estate Finance at Mississippi State University.