As I said in a previous post, there is a gap between the initial loan payment and the real loan payment in the US housing market. Let me explain what I mean. Fixed Rate Mortgages (FRM) are loans with level payments, which means that loan payments are constant in nominal terms. In contrast, if inflation is positive, the income of borrowers grows in nominal terms, so the loan payment to income ratio decreases with time. For example, for a median-income family, a $500 loan payment implied a greater financial effort 20 years ago (when the median income was $35,000) than today ($60,000). The blue line in graph 1 shows the typical evolution of the loan payment to income ratio of a borrower with a FRM. The red line shows the evolution of a mortgage with a constant loan payment to income ratio (what I also call the real loan payment). Take into account that both streams of payments have the same Net Present Value, so a lender/borrower should have no preference between them.

Graph 1

Graph 1

As we can see in the left side of the Graph 1, in year 1 there is a gap between the initial loan payment of the FRM (blue line) and the real loan payment (red line). Borrowers with a FRM have higher initial loan payments than the real loan payment. In Graph 2, I show an estimation of the evolution of this gap in the US mortgage market between 1975 and 2010. It shows the ratio between the real loan payment and the initial loan payment of a FRM. For example, a reading of 75% means that a FRM-borrower would need to pay initially $1000 although the real payment is $750 ($750/$1000 = 75%). The question is: How many families and households would have been able to get a loan (and buy a house) if they had to pay $750 but did not get it because the initial loan payment was $1000?

Loans like Fixed Rate Mortgages bear a hurdle for low-income families because they force them to make an unnecessary financial effort during the early years of the mortgage. If we were able to reduce this hurdle, we could expect an increase in low-income families' affordability and the homeownership ratio. Real rate mortgages or inflation-indexed mortgages can solve this problem and may help to increase the homeownership ratio. They have a stream of payments with a constant loan payment to income ratio (like the red line in graph 1).

Graph 2