Fannie Mae and Freddie Mac both recenty rolled out individual low down payment mortgage products in order to expand the credit box for first-time homeowners. But rather than welcome the news, critics raised concerns that lending could be returning to the practices that led to the housing crisis.
According to one party that is making those loans a reality, those concerns are wrong.
Low down payment options are not exclusively tied to repeat of the loose lending standards of the financial crisis.
The latest Housing Market Insight & Outlook report from Freddie Mac, clarifies that low down payment options are different this time.
Back in March, Freddie Mac launched its Home Possible Advantage program, an affordable conforming, conventional mortgage with a 3% down payment to help more first-homebuyers and other qualified borrowers jump into the market.
This was shortly after Fannie Mae started offering its My Community Mortgage product with a 3% down payment. The programs allow those low-down-payment mortgages to be securitized by the government-sponsored enterprises.
“It’s undeniable that reduced down payments are one of the risk factors that lenders must consider. When a borrower defaults, a high loan-to-value ratio (that is, a low share of borrower equity in the home) increases the lender’s loss,” the report stated.
However, the report added, “These concerns overlook important differences between today’s carefully crafted low down payment programs and the looser practices of the past. Programs like Home Possible Advantage include features that counterbalance the risk associated with lower down payments.”
So what went wrong before? Freddie outlined and compared four variables that changed from during the crisis to after.
Here's is what is was like before and during the crisis.
Loans with low initial payments were prevalent. Beyond adjustable rate mortgages with introductory teaser rates, many borrowers took out interest-only loans.
In the mid-2000s, some lenders assumed ever increasing house prices would limit their risk in the event of default. As a consequence, these lenders placed less emphasis on the ability of the borrower to pay under the terms of the mortgage. Borrowers with lower credit scores found it easier than usual to obtain loans.
During the precrisis period, when house prices were increasing rapidly, it became difficult for appraisers to assess the value of a home. In addition, business practices at the time allowed real estate agents and lenders to influence the choice of appraiser, putting pressure on some appraisers to confirm values that turned out to be inflated.
Borrower “irrational exuberance”
In the mid-2000s, the housing boom increased consumer willingness to stretch financially when purchasing a home.
Here’s how these variables changed and are no longer reasons for another financial crisis.
Today the market is dominated by fully-amortizing, fixed-rate loans. Not only do these loans avoid the payment shock that got so many borrowers into trouble, over time they pay down the principal balance of the loan and increase the borrower’s equity.
Current underwriting standards focus on the borrower’s ability and willingness to make the mortgage payments rather than on the value of the property. Lenders are cautious about extending credit to borrowers with low credit scores or histories of difficulty handling debt.
Improved appraisal practices
An important post-crisis reform has been the emphasis on independent appraisal, uninfluenced by lenders, real estate agents, or anyone else who has a financial interest in the outcome.
Realistic borrower expectations
Just as the Great Depression spawned a generation of risk-averse savers, the recent financial crisis has had a sobering effect on borrower attitudes toward the risks of investing in housing.