Why Are Loans With Little Down Controversial?

Written by Peter G. Miller
on March 25, 2015 No Comments
Categories : Blog View

BLOG VIEW: The nothing-down mortgage is back – the logical next step in a lending environment that has been substantially easing for the past several months.

But, are loans with little down a good idea? Weren't they at the heart of the mortgage meltdown?

The race to the bottom began in October when Mel Watt, director of the Federal Housing Finance Agency, announced that he would direct Fannie Mae and Freddie Mac to purchase mortgages with 3% down. This was an effort, he said, to help ‘lower-wealth borrowers,’ presumably a group defined by an inability to meet the 5% down standard that had long been in place for the two government-sponsored enterprises (GSEs).

Watt's announcement may have been good news for prospective borrowers, but it surely undercut the Federal Housing Administration (FHA), the long-time leader in the little-down financing category with a requirement for as little as 3.5% up front.

The FHA plainly had new competition â�¦ but that wasn't all: Congress passed a last-minute budget in December, which, among its 1,603 pages, just happened to say that ‘none of the funds made available by this act nor any receipts or amounts collected under any FHA program may be used to implement the Homeowners Armed with Knowledge (HAWK) program.’

HAWK was a program scheduled to start this year that would have rewarded borrowers with lower mortgage insurance premiums in exchange for taking homeownership classes and making payments on time. The U.S. Department of Housing and Urban Development (HUD) estimated that typical borrowers in the HAWK program could cut their insurance costs by nearly $10,000 over the life of the loan.

No problem. HUD followed congressional instructions, dumped HAWK, and then announced in January that it just happened to have a new goody for mortgage borrowers: The annual mortgage insurance premium would be reduced for most borrowers from 1.35% to 0.85%, the equivalent of a half percent off the interest rate.

You can see a trend here â�¦ and so the next step was entirely predictable: Someone would soon come along with a zero-down mortgage. Sure enough, in February, BBVA Compass – a bank with almost 700 Sunbelt branches from California to Florida – announced that it would not only offer no-money-down financing to qualified low- and moderate-income borrowers but it would also kick-in as much as $4,500 toward closing costs.

Is the movement toward nothing down is a return to the toxic loan era, the period before 2008 when mortgages were widely available with nothing down and no documentation?

‘The real issue for today's new loans with little upfront concerns related underwriting standards,’ says Rick Sharga, executive vice president at Auction.com. ‘For instance, will we make loans to borrowers who are so thinly capitalized that less overtime or a few missing paychecks are enough to set-off a foreclosure? According to the Consumer Financial Protection Bureau, the typical payday loan is just $392, meaning that millions of people – no doubt including a lot of 'lower-wealth borrowers' – have so little in savings that a $400 bill for new tires or a plumbing repair can force them into debt.’

Little down – by itself – does not suggest increased investor risk. The Urban Institute points out that loans with down payments between 3% and 5% have virtually the same default rate as loans with 5% to 10% down.

Also, we're not back to the toxic loan era in another sense: As the Mortgage Bankers Association explains, under Dodd-Frank the Ability to Repay rule now ‘prohibits creditors from making residential mortgage loans unless creditor makes good faith determination, based on verified and documented information that, at time loan was consummated, consumer had reasonable ability to repay loan according to its terms, and all applicable taxes, insurance and assessments.’

Translation: No doc loans are dead and to avoid buy-backs lenders have every incentive to carefully underwrite new mortgages.

Loans with little down are a test of today's new regulatory environment. Whether that test will be passed or not is something we won't know for several years. In the meantime, if you need a mortgage with little down, lenders will fight for your business.

Peter G. Miller is a nationally syndicated real estate columnist. His books, published originally by Harper & Row, sold more than 300,000 copies. He blogs at OurBroker.com and contributes to such leading sites as RealtyTrac.com, the Huffington Post and Auction.com. Miller has also spoken before such groups as the National Association of Realtors and the Association of Real Estate License Law Officials.

(Do you have an opinion to share with MortgageOrb? Get in touch! Send an email to pbarnard@zackin.com.)

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