What is the low down on low downpayment mortgages? Gerald Hanweck, Gary Fissel and I attempted to unravel the dangers to the financial system (or taxpayers) of low downpayment mortgages during the financial crisis. (The attached paper is forthcoming in Journal of Fixed Income.)
The FHA guarantees low down payment mortgages as do Fannie Mae and Freddie Mac. To compensate for the obvious risk of a 3% downpayment mortgage, Fannie Mae and Freddie Mac generally require stronger credit than with a 20% downpayment mortgage.
During the financial crisis we saw home prices plunge from 2005-2011. Low DP mortgages experienced higher defaults than 20% downpayment mortgages. But we have seen home prices soar since 2011 coupled with tighter lending standards. Hence the demand for 3% downpayment mortgages to solve the affordability problem.
Low downpayment mortgage present little risk to lenders/investors as long as home prices continue their meteoric rise. But if home prices turned downwards (see 2005-2011), WATCH OUT!!
One of the problems facing Federal housing policy is The Federal Reserve. Yes, but pushing interest rates to near zero, The Fed has chased investors from Treasury investments into riskier assets such as housing. Hence, low downpayment mortgages are almost a necessity. Thanks to The Fed.
So now we have housing policy chasing rising home prices. Good luck to Marcia Fudge, the new HUD Secretary and the replacement for Mark Calabria, the current FHFA Director. Susan Wachter or Mark Zandi?