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Will the fixed-rate mortgage become extinct?

Andrew Unangst | Photographer's Choice | Getty Images

While homes will evolve considerably over the next 25 years, it is the way homes are purchased that will bear the heftiest transformation.

As the current path progresses, mortgage financing will look worlds apart from its current form. The government won't be offering the same guarantees as it's been for generations, big banks won't have the same incentives to get in the business, and borrowing rates will be considerably higher as regulation continues to increase.

Interviews with numerous pros in the business paint a picture of big changes to come—not all of them consumer-friendly. Most spring from a dual dynamic of the government seeking to avoid calamities like the one that triggered the financial crisis in 2008 and the industry trying to innovate and continue to profit in a more restrictive environment.

"Even in normal times, we are going to see in all likelihood higher rates, particularly for less-than-stellar borrowers," said Greg McBride, chief financial analyst at Bankrate.com, which provides consumers with information about the latest borrowing data and trends. "Anybody who's got a smaller down payment, some weakness in their credit history or isn't fully documented is going to face the hurdle of higher interest rates and potential limited credit availability."

That may not sound like a terribly bad thing to some ears.

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After all, it was profligate lending to lower-quality borrowers that helped trigger the crisis. Wall Street paved the rest of the way, bundling those mortgages into securities that it sold to yield-hungry investors. When those packages of bonds went bust, large institutions saw their liquidity run dry, and some of the biggest names on the Street—and banking, in general—went under, while the government spent hundreds of billions rescuing others.

Two of the most significant entities in the debacle were Fannie Mae and Freddie Mac, the two government-sponsored enterprises that guaranteed so many faulty mortgages.

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They were bailed out, too, and since then, the government has moved to prevent similar risk to taxpayers in the future. The efforts have culminated in a reform package that would substitute Fannie and Freddie with something called the Federal Mortgage Insurance Corporation. In the ideal, the agency will act in much the same way as its twin predecessors but with more risk to the private sector.

In practice, there's fear that the move will chase lending institutions away from making 30-year mortgages, force a nationalization of the banking system and disrupt a system that was fine by design but flawed in execution.

Whichever the case, the removal of an 80-year-old method of mortgage financing would represent a sea change in the pursuit of the American dream and is easily the most important trend awaiting housing over the next 25 years.

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"I'm pretty skeptical that we're actually going to get a sustainable post-Fannie Mae/Freddie Mac housing market," McBride said. "If we do, I think that certainly mandates the increased desire for non-government-backed securities, and in particular, the role of shadow banking would increase."

Shadow banking is a nefarious-sounding but perhaps unfair term for nonbank lenders, such as Quicken Loans and Lending Tree.

The industry earned its scarlet letter during the crisis by being one of the prime suppliers of the low-quality loans that triggered the liquidity landslide. Countrywide Financial and its fly-by-night brethren became the face of the crisis as they loaned directly or indirectly—through loan servicing—to individuals who oftentimes borrowed without proof of income or agreed to mortgages that began with low "teaser" rates that surged following an introductory period of a year or two.

Non-bank lenders, though, are looking to regain their footing by raising lending standards and positioning themselves as alternatives to big banks that are reluctant to get into the low-profit high-risk business of home lending.

As a result, U.S. shadow-bank assets are up to $16 trillion, more than traditional banks.

Housing experts see shadow banking, as well as the emergence of more smaller lenders into the space, as the biggest collective trend the market will see in the generation ahead.

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"It's going to be a regulated market in theory in a post-Fannie and Freddie Mac world, but it's going to be a market with distinctly private players who can have more flexibility in terms of their pricing, in terms of who their customers are," said Guy Cecala, CEO at Inside Mortgage Finance, a widely followed industry news and data source. "Government and/or taxpayers have been able to impose public-policy requirements. ... I don't think that would be easy to continue in this world."

The mortgage financing business has always been a bit of a quandary for big banks: Customers demand it, but the profit benefits aren't as good as many other parts of the business.

With the landscape shifting and the current atmosphere in Washington decidedly hostile to large financial institutions, many might simply quit the business and move on to other, less volatile areas.

While limiting consumer choice, it opens the door for other institutions to step into the breach.

"There certainly is an opportunity for different, smaller banks to enter into different parts of the market for all types of financing," said Jason Auerbach, divisional manager for First Choice Loan Services in Morganville, N.J. "Smaller banks have stepped up and have been able to insure that the housing market can continue to grow."

Auerbach's company is a subsidiary of First Choice Bank, which has just under $1 billion in assets. It ranked 680th in total assets at the end of 2013, according to usbanklocations.com. Yet the company is finding opportunity in the mortgage marketplace.

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"Large banks—they're not going too far outside the box," Auerbach said. "We are willing to offer niche products. You're going to see more banks turning into that marketplace."

Among the company's finance offerings: construction and renovation for jumbo borrowers, planned development communities, and condominiums and cooperatives that don't meet Fannie and Freddie guidelines. In fact, most of what the company offers falls outside the normal government guarantees, making it well positioned once the new structure takes effect in the coming years.

The $138 billion industry for Veterans Affairs loans offers another opportunity for the future of financing.

Grant Moon, founder and president of VA Loan Captain, said there will be a big market for finding homes as the U.S. unwinds its foreign entanglements.

"You have a lot of young people integrating back into society after fighting two decade-long wars. Then you have a reduction in forces going on from a military capacity point of view," Moon said. "What we've been seeing is continuous growth within the veteran loan industry, which is a unique mortgage in and of itself."

On the undercurrent of the sea change, though, is a sense of foreboding.

After all, the government is entering uncharted waters in trying to unwind a system that has prevailed for 80 years, so it's probably unrealistic to imagine that the new way of doing things will go off without some pretty significant hitches.

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High-profile banking analyst Dick Bove, the vice president for equity research at Rafferty Capital Markets, has been raising his voice loudly in defense of the current system. He has been painting a dystopian picture of a government that frees itself of the unpopular dual-mortgage guarantors and replaces it with a nation of renters, where housing is unaffordable and inaccessible.

In one of his recent treatises on the subject, Bove had this to say:

The decision to tear apart the financial structures that were created over the past 80 years carries significant risk. The risk is that slums will be created across the nation as low- income households live together in ghettos, where the ownership of housing may be in large financial conglomerates far removed from the neighborhoods being impacted.

Moreover, housing subsidies, this well-used tool to stimulate economic growth in recessions, will be gone. Further, the transition from a subsidized industry to a privately driven real estate business carries with it the risk that the value of every home in the United States will decline in value, causing a recession.

Extreme? Time will tell. Many Washington political insiders doubt the current proposal to unwind Fannie and Freddie will succeed in its current form.

Those who subscribe to Bove's point of view certainly hope not. Others, it seems, will be left to sort through what's left over and find opportunities if the reform plan becomes law.

A final view on what Bove sees for the future:

The basic fact remains, the system of home finance created by this nation has served its people unusually well for 80 years, and I do not believe that it is about to be scrapped. (Former Federal Reserve Chairman) Alan Greenspan said in a CNBC interview that the Dodd Frank Act (to reform the banking system) was put in place by people who never sought to discover the reason of the Great Recession and that Dodd Frank is harming the economy.

I cannot believe that Congress is going to do this again in housing. This time, they will feel the brunt of the American people's anger as housing prices tumble across the country as ill-advised poorly-thought-out populist legislation is once again put in place.

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