Again, I agree with what you say. I just think the value risk is one-sided. Presumably, a lender acting in good faith is agreeing on current value in exchange for property forfeiture in the event of default. In other words, no bank will lend me $200k to buy a $100k house. Why? Because the transaction implies an agreed upon value by both parties.
Now, it seems to me (not legally, but logically) that both parties are assuming some risk in this transaction. The lender's risk is mitigated through foreclosure rights along with already collected interest payments, the borrower's through potential capital gains. But in the current structure, the lender's risk is additionally mitigated by its ability to recover the "original value" of the property regardless of market determinations at the time of seizure.
So in some respects, heads: both parties win. Tails: lender wins and borrower loses.
Both parties are assuming some risk in this transaction. The bank is assuming the risks associated with loss of the principle, and opportunity cost of the loaned funds. The bank attempts to migitate these by requiring homeowner's insurance, private mortgage insurance, etc. The bank still runs the risk that the homeowner will fail to maintain insurance requirements, and ultimately fail to pay. The bank risks that attempts to collect the remainder of the principal will fail if the borrower has diminished the value of the secured asset (damaged it, failed to maintain it, burnt it down, blown it up), has no other compensatory assets, becomes deceased during the term of the agreement and cannot satisfy the debt with estate proceeds, etc. The bank earns an agreed interest rate as compensation for the risk of nonpayment and/or loss of the secured asset, assured opportunity cost (the money the bank might have made investing the funds with the fed, etc.) and for forgoing any returns for appreciation of the asset (ie. the money the bank might have made if they had purchased and owned the property outright and later sold for a profit).
The homeowner's risk is that the value of the property will decrease. If the value of the property goes up, the homeowner gains all of the benefit. When entering into the loan agreement, the reasonable homeowner hopes the property will retain or increase its value, but understands a loss is possible.
If you wanted the bank to participate in the downside risk, then you would have to let the bank participate in the upside. I wouldn't be thrilled about having to cut the bank a check for part of my profit when I sold a home. If they were willing to participate in the downside they would probably just buy the property outright, and leave you out of the transaction.
As far as 'front-loading' the interest... the interest is charged based on the amount of money being loaned at a particular point in time. If the loan principal amount is $100,000, the first monthly payment includes interest based on the $100,000, and an additional amount to reduce the principal for the next month. The principal payments reduce the loan amount, which reduces the interest amount for the next period. With each period, the outstanding principal amount shrinks, so the interest amount shrinks. This increases the amount of principal paid in the next level payment until all of the principal has been paid off.
Nothing prevents the borrower from paying additional principal each month. The more the outstanding balance is reduced, the less interest is charged each month. During the initial loan period, additional principal payments can make a big difference in the total amount of payments over the life of the loan.
If the bank were to artificially spread the interest cost across the life of the loan (eg. charge the same amount of interest whether the remaining principal was $100,000 or $1), then they would risk a substantial loss if the loan was paid off early. For much of the life of the loan, the real interest earned on the outstanding principal would be far less than the market interest rate plus the time value of money. And ultimately the homeowner would be upset with paying $999 interest on $1 outstanding principal at the end of the loan period.
Ultimately, individuals seeking to buy expensive assets such as real estate benefit by access to loans. Over time, these assets tend to appreciate to levels in excess of market interest rates. Banks are only going to make loans if they can be assured of recovering their principal and making a market level return on their investment. The alternative would be to expect buyers to pay cash in advance.. but then there would be a significant segment of society complaining that they couldn't afford a home.
“In other words, no bank will lend me $200k to buy a $100k house. “
Of course they would IF they thought you would pay them back. The house just helps the agreement. If your FICO score was 200, the bank wouldn’t lend you the money period, no matter the value of the house.
People used to get unsecured loans all the time. The bank lent you the money so you could buy a house. They didn’t buy a house and rent it to you.