There are many more potential buyers with little or no savings than there are those with hundreds of thousands in cash in the bank. The size of the potential buyer pool rises or falls dramatically with changes in down payment requirements. A high down payment requirement greatly reduces the potential buyer pool whereas a low down payment requirement greatly increases it. This basic fact is why lenders and their lobbyists are working so hard to get down payment requirements lowered or eliminated. Any down payment requirement is an impediment to doing more business. In fact, if down payment requirements were reduced to zero, that barrier to home ownership would be effectively removed. Lenders tried that during the housing bubble, and it was a disaster. Lots of people who didn’t have any savings — or any sense of financial responsibility — took lenders up on their generous offers for free houses. This was a major contributor to the housing bubble and bust, and the resulting losses cost lenders — and taxpayers — billions.
Lending losses are the negative side effect of low down payment requirements. Lenders want to eliminate the down payment requirements to make more money on originations, but then they want to sell these loans off to investors, mostly with taxpayer backing, so they don’t have to absorb any losses when their loans go bad. The originate-to-sell business model is the best of both worlds. They get all the profits, and they pass all the losses on to someone else. It’s a very desirable, and very corrupt, business model. Lenders hoping to operate on the originate-to-sell model are behind the intense lobbying campaign against any kind of down payment requirement.
Because the buyer pool with substantial down payment savings is so small, there’s no doubt that raising down payment requirements will hinder lending, and in the process, it will slow the pace of the so-called housing recovery. Further, it will make it much harder to reduce the government’s footprint in housing finance because private money will be very hesitant to make loans with lower down payments. Right now, there is no private lending with less than 20% down unless the loan has explicit government backing through the FHA or the GSEs. The only way private money will provide loans with less than 20% down is if the qualified residential mortgage rules will allow them to do so and obtain their “safe harbor” status.
Politicians and bureaucrats are currently drafting the rules for the qualified residential mortgage. Unlike the rules for the “qualified mortgage” defined recently (see How the new mortgage rules will impact the housing market), the new qualified residential mortgage rules are expected to have specific limits set for down payments. This new down payment standard won’t be an absolute requirement. Lenders can still make loans with less money down, but then they must retain 5% of such loans on their own balance sheets as an incentive to manage risk. As evidenced by the intense lobbying against any down payment requirement, lenders want to originate as many bad loans as possible with no accountability whatsoever. Hopefully, politicians and bureaucrats will make the more difficult but much wiser decision to set down payment requirements at 20%. We’ll see soon.
By Brandon Cornett | March 13, 2013
Will we see a mandatory 20% down payment on mortgage loans in 2013? Probably not. But a lower mandatory down payment, say, 5% or 10%, seems possible at this point.
The very idea of it has mortgage lenders holding their breath — and lobbying with their collective might.
In the summer of 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, or H.R. 4173. It was the most sweeping set of financial reforms since the Great Depression, with more than 1,400 pages of proposed rules and requirements.
Among other things, the Dodd-Frank Act introduced a concept known as the qualified residential mortgage, or QRM. A qualified residential mortgage loan is one that meets certain standards that are designed to reduce risk. The final definition is forthcoming, but it will likely incorporate many of the risk-reducing features of the similarly named (and recently finalized) qualified mortgage, or QM.
The new qualified mortgage rules were good. (see New mortgage regulations will prevent future housing bubbles)
Lenders will have a strong incentive for making QRM-compliant loans. They can sell them into the secondary mortgage market without limitation.
According to the Dodd-Frank Act:
“a [mortgage] securitizer is not required to retain any part of the credit risk for an asset that is transferred, sold or conveyed through the issuance of an asset-backed security by the securitizer, if all of the assets that collateralize the asset-backed security are qualified residential mortgages…”
In other words, lenders do not have to keep QRM loans on their books.
Banks used to keep all loans on their books. Their business was to loan money and profit from the interest payments over time. Bankers had a strong incentive to underwrite good loans because if they didn’t, they lost money. The originate-to-sell model doesn’t have that incentive. Their incentive is to make as many loans as possible, regardless of quality, and pass the risk on to someone else. It’s the worst possible set of incentives. If this subset of mortgage lenders gets their way in Washington, we will likely inflate another costly real estate bubble at taxpayer expense, and companies like New Century will spring up, make millions, and fold up when the market implodes.
Mandatory Down Payment: Facts, Rumors and Fears
What does QRM have to do with mandatory down payments on mortgage loans? So far, nothing. In fact, the words “down payment” only appear once in the full text of the Dodd-Frank Act, and only in a historical sense. There is nothing in the legislation that ties the QRM standard to a certain down-payment amount.
So why has this subject been making headlines for well over a year? Here’s what started the debate:
“These underwriting standards include, among other things … a maximum loan-to-value (LTV) ratio of 80 percent in the case of a purchase transaction (with a lesser combined LTV permitted for refinance transactions); a 20 percent down payment requirement in the case of a purchase transaction…”
This quote comes from the Notice of Proposed Rulemaking published by federal banking regulators in March of 2011. This is the match that lit the fuse of controversy, complaint and lobbying. Though this was only a proposal (and there’s a wide chasm between proposal and passage, when it comes to federal laws), it did signal the desires of regulators to impose a 20% down-payment rule for purchase mortgages. It’s right there in black and white.
Let’s hope that requirement remains in black and white in the final draft of the rules. With all the lobbying for a zero requirement, I suspect a 5% or 10% requirement is more likely despite the obvious risks to taxpayers, homeowners, and communities when lenders inflate another housing bubble.
The coalition commented on mandatory down payments in a 2013 recent press release.
“Low down payments alone were not the cause of the crisis,” said Julia Gordon, a coalition member and Director of Housing Finance and Policy at the Center for American Progress. “With appropriate underwriting and borrower support, low-down payment lending can be extremely safe and provide families with the opportunity to own homes in stable communities and build wealth for future generations.”
Complete and utter bullshit. Low down payment lending is not safe. Subprime imploded and no longer exists. The federal agency that stepped into the role of subprime, the FHA, has serious delinquency rates over 10%, and they are losing money so fast that they will require a government bailout. Low down payment lending destabilizes communities because it leads to sky-high delinquency rates and foreclosures.
This is the worst kind of disingenuous lie that comes from lobbyists. It’s bullshit, everyone knows its bullshit, but when laden with emotional appeals, it sounds plausible and enticing. Low down payment requirements with no accountability only serves the narrow profit interest of lenders. It’s greed over good, a triumph for evil.
The prospect of high down payment requirements has originate-to-sell lenders worried. They are trying to scare lawmakers with the negative impact higher down payment requirements will have on their business. Hopefully, lawmakers won’t listen.
… Industry groups described the CFPB action as largely workable. But they have raised concern about the additional regulations under joint consideration at the Housing Department, the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Federal Reserve and the Federal Housing Finance Agency.The industry and consumer coalition fears that those yet unveiled regulations, dubbed QRM — or “qualified residential mortgages” — would go too far.
“The coalition strongly opposes the addition of stringent down payment and other restrictive requirements to the QRM definition that will ultimately limit the ability of private capital to reach lower income households and first-time buyers,” the group wrote in its letter to the regulators. “QRM should not be more restrictive than QM.”
No timetable has been designated for the QRM rule, but regulators have said it would be issued soon.
The most stabilizing mechanism available to policymakers is a sizable down payment. Economists would classify a down payment as a sunk cost that should be ignored when considering selling an asset for a loss. However, homeowners don’t simply forget about their cash when it’s sunk into a property. The larger the down payment, the less likely a borrower is to strategically default regardless of how far underwater they may be. Borrowers with large down payments will wait until prices rise enough for them to get their money back — no matter how long that takes. Since borrowers who put large amounts down don’t strategically default or sell for a loss, large down payments have a stabilizing impact on the market.
For lenders and investors in mortgage-backed securities, large down payments provide a buffer that minimizes their losses if borrowers do default. Any down payment of 10% or more allows the borrower to sell, pay closing costs and commissions, and fully repay the loan. Down payments of 20% or more gives the lender a buffer of 10% in cases prices decline while the borrower owns it. Price drops of 10% or less are possible in a weak economy even if lenders don’t inflate a bubble. Large down payment requirements serves borrowers, lenders, and ultimately taxpayers who end up subsidizing and backstopping both parties. It doesn’t serve the short-term desires of originate-to-sell lenders, and implementing high down payment requirements will impact the efforts of lenders to reflate the last bubble, but for the greater good, down payment requirements must be at least 10% with 20% being preferred.
More than doubled his mortgage
From the bottom of the previous housing bubble in 1997 to the peak of the latest housing bubble in 2006, prices rose about 250% across Southern California — so did this borrower’s mortgage. This former owner’s mortgage went from $188,700 to $455,000 in 2006. That’s a lot of mortgage equity withdrawal. He defaulted sometime in early 2010 and was allowed to squat for over a year. Then the bank sat on this property for a year and half until they finally put it on the market.
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Proprietary OC Housing News home purchase analysis
$303,500 …….. Asking Price
$185,000 ………. Purchase Price
5/2/2001 ………. Purchase Date
$118,500 ………. Gross Gain (Loss)
($24,280) ………… Commissions and Costs at 8%
$94,220 ………. Net Gain (Loss)
64.1% ………. Gross Percent Change
50.9% ………. Net Percent Change
4.1% ………… Annual Appreciation
Cost of Home Ownership
$303,500 …….. Asking Price
$10,623 ………… 3.5% Down FHA Financing
3.65% …………. Mortgage Interest Rate
30 ……………… Number of Years
$292,878 …….. Mortgage
$77,736 ………. Income Requirement
$1,340 ………… Monthly Mortgage Payment
$263 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$76 ………… Homeowners Insurance at 0.3%
$329 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,008 ………. Monthly Cash Outlays
($260) ………. Tax Savings
($449) ………. Equity Hidden in Payment
$13 ………….. Lost Income to Down Payment
$96 ………….. Maintenance and Replacement Reserves
$1,408 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$4,535 ………… Furnishing and Move In at 1% + $1,500
$4,535 ………… Closing Costs at 1% + $1,500
$2,929 ………… Interest Points
$10,623 ………… Down Payment
$22,621 ………. Total Cash Costs
$21,500 ………. Emergency Cash Reserves
$44,121 ………. Total Savings Needed