By Nikitra Bailey
Just as we are beginning to see signs of recovery in housing, federal regulators are considering a policy that could threaten economic progress and financial opportunities for middle-class families. This policy would require a 10 percent or other minimum down payment on home loans before the federal government will label them “safe” as “qualified residential mortgages.”
This could determine who will or won’t be able to obtain an affordable, mainstream home mortgage to share in the American dream.
Some now talking about high mandated down-payment requirements blame low- and middle-income families for triggering the devastating foreclosure crisis that sent our national economy into a deep recession. But blaming low-income families and casting them as unfit to own a home ignores decades of successful mortgage lending before the subprime boom — before reckless underwriting and aggressive marketing of unsustainable loans became common financial industry practice.
Responsible lenders have originated loans to low- and middle-income borrowers with small down payments successfully for more than 50 years. Between 1990 and 2009, there were more than 27 million mortgages with low down payments but without the risky loan features that triggered high default rates. These loans not only helped millions of low- and moderate-income families successfully become homeowners, they also performed well — producing limited losses for lenders, investors and taxpayers.
Consider, for example, the difference between typical subprime mortgages and mortgages insured by the Federal Housing Administration from 2005 to 2007. These loans were made available to borrowers with similar credit scores and debt positions, and for which the down payment was less than 10 percent.
The subprime loans, however, typically contained multiple risky loan features — including no income documentation, prepayment penalties and interest-only payments. In contrast, the FHA loans lacked these risky features. As data from the period shows, the FHA loans performed far better than the subprime loans, with subprime default rates three to four times higher than those for FHA loans made to comparable borrowers.
The Dodd-Frank Act has now banned many of the risky mortgage practices of this subprime lending market. For example, lenders must now document income, and they no longer can charge expensive penalties for early payment or give kickbacks to mortgage brokers for placing borrowers in higher rate loans than they qualify for.
The act also creates new standards for how mortgage risk should be determined. Under Dodd-Frank, mortgage lenders who sell their loans into the private secondary market must retain a portion of the loan’s risk — unless the loan is designated as a “qualified residential mortgage.”
With Dodd-Frank’s reliable mortgage lending rules, qualified residential mortgages don’t need federally mandated down payments. The costs far outweigh the benefits.
Consider: Research has shown that, now that the risky loan products and practices are banned by Dodd-Frank, a 10 percent down payment requirement would have only a marginal effect on default rates — about 1 percentage point. Meanwhile, this could lock 30 percent of borrowers out of the mainstream market.
By mandating a 10 percent down payment , regulators would prevent many middle-class families from entering the mainstream mortgage market. Some people have the good fortune of getting money for a down payment from their parents or other family members, but not everyone has that option.
Given the cost of a median-priced home and median income, the average American family would need to save for more than 20 years to acquire a 10 percent down payment plus closing costs. That represents a huge lost opportunity during this time of great housing affordability and historically low interest rates for lower-income borrowers — including teachers, police officers, firefighters and military personnel living in states like North Carolina, Ohio and Colorado.
Saving for a home takes even longer for African-American and Latino families, who also are more likely to rely entirely on their own funds rather than family gifts. The necessity to save for decades creates an unreasonable barrier to wealth-building opportunities. For example, if a mandatory 10 percent down-payment requirement had been in place for borrowers who received loans between 2004 and 2008, 60 percent of African-American borrowers and 50 percent of Latino borrowers would not have been able to obtain mainstream loans. And these are borrowers who are now paying their mortgages on time.
A mandatory 10 percent down payment would not only be bad for those families; it would be bad for the entire economy, given that a majority of new households over the next decade will comprise non-white families. Locking out potential buyers who could be successful homeowners would decrease housing demand and slow economic recovery. That hurts everyone.
A government-mandated down payment requirement of 10 percent could also create a “dual market” — where minority and moderate-income borrowers are relegated to fringe mortgage products from outside the financial mainstream.
Yes, borrowers should have “skin in the game” that represents their stake in the house. But the market should decide how much. Three percent down for a low-income family may be just as effective a personal investment as 20 percent down for a wealthier one.
Nikitra Bailey is an executive vice president at the Center for Responsible Lending, a nonprofit, nonpartisan organization that works to protect homeownership and family wealth by fighting predatory lending practices.
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