First of all, I believe that prepayment penalties are key. In Sweden, if you pay off a fixed-rate mortgage before it expires, you have to pay for the interest rate differential between the fixed rate you’re paying and the fixed rate the lender can get in the market by investing the money you lent in an equal investment. With 10 years left on a mortgage, this can work out to a very hefty sum …
Secondly, I do believe that there should be no closing costs or points involved in getting a mortgage. This means that, as long as your mortgage is not a fixed rate mortgage, you can move your loan to another lender at any point in time, with zero cost. This promotes competition and promotes the use of adjustable rate products …
You also need to make mortgage recourse loans. You need to make sure that mortgage decisions are based on the verified income of the borrower, and not only on the assets of the borrower … Also, you need to make sure that you can not borrow nearly 100% of the property value.
Finally, one thing that is desperately needed is new and strong regulation on what sort of mortgages that can be securitized. This also means that we can rather easily find solutions to how to get the other things to happen. New laws regarding the creation of mortgage backed securities could require that any mortgage packaged into an MBS fulfill the requirements I mention. It would be illegal to market mortgage based securities if they do not fully consist of recourse mortgages with prepayment penalties, no closing costs, a verified income that is high enough to handle the mortgage and a reasonable loan-to-value.
If this was to be implemented in the US, I believe the the federal reserve would have the tools necessary to better ensure sane credit availability and avoid the current boom and bust cycle.
BTW, we have a very similar system in Canada, where our banks remain stable, houses continue to be sold, and mortgages are still being given out.
It’s amazing to me that we (that is the U.S.) would let our housing and mortgage system undermine our banking system and real economy.