[Correction: A previous version of this article referenced Urban Institute as the source of research on delinquency. The research is from Neil Mayer and Associates and Experian.]
After reading some of the recent reports on HousingWire and other outlets on the limited return or the risk associated with low down payment mortgages, plus the comments accompanying those articles, a reasonable person would think a low or even zero-down payment mortgage is a very dangerous proposition.
In fact, nothing could be further from the truth. I would suggest down payments as an indicator for mortgage performance is one of the most misunderstood factors in evaluating lending risk.
The mortgage market today is very different than it was just before the start of the most recent housing crisis and the incremental moves taking place now to provide opportunity for homeownership to credit-worthy borrowers who are committed to doing what it takes to be long-term, successful homeowners are what the market needs. They’re good for consumers, for the housing and mortgage industries and ultimately a critical step in stabilizing many communities across the United States
The rate of job growth is strong and overall economic activity measured by gross domestic product also is positive. The housing market, however, has not fully recovered, despite the broader march of growth. Before the current conditions, no one would have believed that housing would be such a weak participant in the economic recovery if mortgage rates were as low as they have been for as long. The 30-year fixed rate mortgage has averaged below 4.5% for most of the past 18 months, and for much of that time has been below 4%.
For too long after the housing crisis, lenders kept the credit flow cut off for anyone but the most pristine borrowers, or to those who had the cash to put down at least 20% – often the borrower had to have both. Yes, lower down payment mortgages were available, but obviously not in large enough numbers to move the home sales market from just scraping by.
NeighborWorks America wants the housing market to do more than just scrape by. We want it to thrive because homeownership is a critical part of a strong community and a strong personal financial balance sheet. That’s why low down payment mortgages are so important.
Access to homeownership
Low down payment mortgages provide people who have strong work histories and qualifying income to obtain a piece of something very important to them. A survey conducted by NeighborWorks in 2014 found that 60% of Americans consider homeownership as a very important or most important part of their American Dream.
People who achieve their dreams do not easily let them slip away. One criticism of low down payment mortgages is that the homeowner has too little “skin in the game,” and that they would too quickly abandon their home. These critics are saying that people would blithely abandon their dreams.
Consider the facts: According to research from Zillow (Z) last year, nearly 10 million people lived in homes with some level of negative equity. If equity were the determining factor for default, there would be a lot more mortgages in default.
The truth is, the overwhelming majority of the people who live in homes with negative equity don’t walk away and keep paying their mortgage because they like where they live.
It’s their home. Home matters and people largely do whatever it takes to keep and protect it. Obtaining a home with a low down payment doesn’t diminish the personal value that home represents. The idea of home just may be one of the most important default protections a lender could have.
Making the right housing choice as protection against default
It’s fair for lenders to be concerned about default. They want to be paid back. Who doesn’t? It’s reasonable (if not misplaced in my view) for lenders to be skeptical about the default protection correlation that may exist between home and heart. Equity, however, is not the only protection. An informed homebuyer is a better, less risky homebuyer. NeighborWorks America knows that homebuyer education and counseling mitigates default risk. Research conducted for us by Neil Mayer and Associates and Experian found that homebuyers who received such pre-purchase guidance were about one-third less likely to become 90+ days delinquent than homebuyers who didn’t.
NeighborWorks America wants homeowners to make the right choice when pursuing homeownership, not any choice. We want buyers to shop around for the right mortgage as diligently as they shop around for the right home. Not being an informed consumer could be disastrous. Homebuyer education and counseling gives consumers the tools to make good choices, and good choices for consumers usually mean good outcomes for lenders.
I’m not suggesting that homebuyer education is required for low down payment borrowers. I’m saying that homebuyer education and counseling mitigates risk, and that’s what the lender wants – reduced risk. In fact, I would suggest that mortgages to borrowers who have been prepared for the purchase and understand the mortgage terms, perform as those borrowers who have 5% to 10% more cash into the purchase — in other words a little more equity doesn’t really mitigate risk in our experience.
Low down payment = more loans, more homes sold, better market
According to the National Association of Realtors existing homes sales report for January, the median price of home sold was about $200,000. For a consumer to put down even a 10% down payment would mean $20,000. That’s a steep hill to climb for the median household, whose income is slightly more than $52,000. The housing and mortgage industries will not rebound if they only look at the size of the pile of cash on the table instead of the size of the borrower’s commitment to save and sacrifice.
Importantly, by enabling a homebuyer to purchase with a small down payment, a lender is fostering a stronger owner. It’s difficult these days for people to save. A financial capability survey NeighborWorks conducted in 2014 found that more than one-out-of-five Americans have no emergency savings. Many of these people are homeowners, who could be one major setback away from a missed mortgage payment. By recognizing that low down payment requirements could mean greater reserves or savings held by the homeowner, a lender could actually be insulating itself from default.
Low down payment mortgages are good for the housing and mortgage industries. They bring in new customers who plant firm roots into communities, and can be done safely. Oh, and low down payment mortgages will bring first-time homebuyers back to the market, too.