It has been this bad before. How home buyers got it done in 1981

The hopeful news is that America has been through this before — in 1981 — and things eventually got better. The sobering news is that the early-’80s housing market stayed alive courtesy of some factors that barely exist this time around. We will have to construct a new path out of this mess.

How 2022 resembles the early ’80s

The similarities between now and then start generationally: In 1981, the oldest baby boomers were 35 years old, and that cohort was in full homebuying mode. The first millennials were born that year, and that next-largest generation has been diligently searching for homes in recent years.

Both generations were walloped by rapidly rising mortgage rates following a series of rate hikes by an inflation-fighting Federal Reserve:

• When the average interest rate on the 30-year fixed-rate mortgage reached an all-time high of 18.63% in October 1981, it had risen almost 5 percentage points in 12 months. Rates had gone up almost as fast during a spell in 1980.
• This year, when the 30-year mortgage reached 7.08% in early November, it had gone up 4.1 percentage points in 12 months. (All percentages are from Freddie Mac's weekly survey, going back to 1971.)

The rapid climbs in mortgage rates forced would-be home buyers to skedaddle out of the market. Year-over-year existing home sales plunged 22.3% in 1980 and then another 18.6% in 1981, according to historical data from the National Association of Realtors. This year, the pace of existing home sales dropped 28.4% in the 12 months ending in October, according to the NAR.

Finally, "rate lock-in" accompanied both eras. That's when homeowners keep their properties off the market because they want to hang onto their low-rate mortgages.

• March 1981: A real estate executive told The New York Times that home sales were being inhibited because "Nobody wants to lose their low-interest mortgage."
• September 2022: NAR chief economist Lawrence Yun said, "Some homeowners are unwilling to trade up or trade down after locking in historically low mortgage rates in recent years."

A big difference: The role of assumable loans

For all the similarities between the 1980s and today, there are key differences. One of them involves “assumable mortgages,” which were plentiful then and are in short supply now.

Many mortgages were assumable at the dawn of the 1980s. With an assumable mortgage, the buyer not only gets ownership of the house but takes over the seller's home loan, too. Picture yourself trying to buy a house when mortgage rates are in the double digits. You find a home seller who has an assumable loan with an interest rate in the single digits. That home may be affordable if you can take over the loan; it might not be affordable at a double-digit interest rate.

Home sellers spotlighted their assumable loans in classified ads. "If you had an 8% loan in a 14% market, it would differentiate your house as far as salability," says Ted Tozer, nonresident fellow with the Urban Institute's Housing Finance Policy Center. He says "a ton" of mortgage assumptions were done in the early ’80s.

But Congress slammed the door on assumable loans in 1982. Now only a subset of mortgages are readily assumable: those insured or guaranteed by the Federal Housing Administration, the Department of Veterans Affairs and the Department of Agriculture's Rural Housing Service. Together, FHA, VA and USDA loans accounted for around 18% of mortgage origination volume in the second quarter of 2022, according to data gathered by the Urban Institute.

An era of creative financing

Assumable loans helped to keep home sales stumbling along in the early ’80s when mortgage rates were extraordinarily high. They also served as the foundation for what was called "creative financing," which filled the gap between the purchase price and the assumed mortgage balance.

In most cases, creative financing took the form of loans to buyers from the sellers; for instance, in the form of a promissory note for a certain amount the buyer would pay the seller every month, with the buyer possibly taking out a second mortgage for the remainder of the purchase price. The arrangements had names such as "contract for deed," "wraparound mortgage" and "lease with an option to buy." A June 1981 Washington Post article said creative financing accounted "for more than 50% of all 1981 home resales in many parts of the United States."

More than 40 years have gone by, and 1980s-style creative financing isn't coming back. Lenders frowned on the ad hoc transfers of loans they had originally made and wanted to write new loans at current interest rates as properties changed hands. Consumer advocates warned of the risk to buyers and sellers of informal and unconventional schemes that could leave either party holding a worthless contract, or committed to an unsupportable payment structure.

A need for new solutions

If 1980s-era creative financing is out of the picture, will banks or Silicon Valley or home sellers come up with 2020s-style resourcefulness? Some ingenuity might be needed to keep home sales sputtering along instead of faceplanting. Maybe it will be something that already exists, but hasn't caught on yet, such as wider adoption of accessory dwelling units, 3D-printed houses or groups of friends banding together to share ownership of homes.

Whatever happens, any predictions will look silly in hindsight. Consider the Dallas real estate agent who spoke to D Magazine in 1980, when the 30-year mortgage was above 15%. "Chances are," he said, "we’ll never see home mortgage interest fall back into the single-digit range again."

Thankfully, mortgage rates did eventually fall into the single digits, where they’ve stayed since 1991. Not only that, plenty of people got 30-year mortgages at interest rates below 3% just last year. History tells us that the housing market will get better, even if we go through rocky times on the way to recovery.