A down payment remains a high hurdle for consumers seeking mortgages. Lowering that hurdle increasingly seems in line with shared industry and regulatory goals-assuming borrowers don't default.
And there's the rub.
Fannie Mae and Freddie Mac, the government-sponsored enterprises that dominate the market, now almost always require 5% down, even with private mortgage insurance. While private insurers will support down payments as low as 3%, the GSEs' regulator sounds wary of letting Fannie and Freddie lean more on these carriers. The Federal Housing Administration allows as little as 3.5% equity, but its premiums are becoming more expensive for borrowers.
On top of everything else, the industry remains concerned about the accuracy of the data used to make loan decisions, particularly appraisals, since valuation errors can make defaults especially costly on a low down payment loan.
"If you're doing high loan-to-value lending at 95% or 97% and you're depending on the appraisal, the appraisal precision may not be sufficient to support it," says Thomas Showalter, the chief analytics officer at Digital Risk, a quality control and due diligence firm based in Maitland, Fla. "You may think you're underwriting a loan with some equity in it, and you're not."
The percentage of purchase loans originated in March that had loan-to-value ratios between 96% and 100% were at their lowest share for this slice of the market since at least 2000, according to the data provider Black Knight.
High down payments persist even though the government wants to expand credit availability, lenders need volume and the agencies are encouraging lenders to remove credit overlays to reach more borrowers. New Federal Housing Finance Agency director Mel Watt advocates many new efforts to reach underserved borrowers in his 2014 strategic plan - but not lower down payments for GSE loans.
This omission disappointed Jason Madiedo, president of the National Association of Hispanic Real Estate Professionals in San Diego and president of Las Vegas-based lender Venta Financial Group.
Slightly lower down payments could help borrowers "tremendously," particularly the Hispanic community, says Madiedo. Many borrowers work in professions where they wouldn't be able to save enough for a down payment quickly enough to buy a house by the time they start a family, he says.
While there are other government-related options that borrowers short of a 5% down payment can turn to, such as state and local Housing Finance Agency programs (which Watt mentions in his strategic plan), private lending and FHA loans, they are less accessible than GSE products, Madiedo says. The share of purchase lending with less than 10% down originated outside of the FHA-the largest alternative federal government source of low downpayment products-has generally risen since it bottomed below 6% in 2009. It has ranged between 15-20% recently.
Lower down payment risks may be a concern but they have less bearing on default than some other underwriting factors. "I don't think down payment amount has been as big a factor as income and credit profile in the performance of a mortgage," Madiedo says.
Micki Pressman, a vice president at Philadelphia-based mortgage insurer Radian, one of the companies that helps protect lenders from default risk on home financing involving loan-to-value ratios above 80%, agrees that these other variables have a bigger impact.
"If someone has a very poor credit history, that's pretty indicative of how they are going to pay but all things being equal, the property value is one component" of overall loan risk, she says.
Sharing the risk with mortgage insurers should address the GSEs' concerns about down payments smaller than 5%, Madiedo says.
However, the FHFA strategic plan suggests there is a need to strengthen the standards for the mortgage insurers, which have historically provided the main mechanism for the GSEs to meet the requirements in their charter for additional credit enhancement to support mortgages with loan-to-value ratios above 80%.
Lax eligibility standards in the past resulted in some mortgage insurers not satisfying their financial commitments over the last few years, the plan notes.
Some lenders are trying to serve the low-down-payment niche without the aid of the mortgage insurers or the GSEs.
TD Bank, a Cherry Hill, N.J. unit of Toronto-Dominion Bank, for example, is courting borrowers who meet certain debt, income and credit criteria with a nonconforming portfolio loan without private mortgage insurance called Right Step.
"Because of the strength and stability in our own lending practices, we have the flexibility to offer the Right Step program to benefit qualified low to moderate income and first time buyers who may not have built up equity in a previous property," says Mike Copley, the bank's head of retail, money-out products.
Even a 5% down payment proved to be out of reach for 63% of prospective millennial generation buyers in a recent Fannie Mae survey, he notes. And since November there has been virtually no way to get a loan with a down payment lower than 5%, even with mortgage insurance, from the government-sponsored enterprises that dominate the mortgage market.
It is unclear why Fannie Mae decided to reduce its maximum loan-to-value ratio in November, according to an Urban Institute report, which noted that a small share of Fannie loans have LTVs between 95% to 97% and the default risk for these loans is only slightly higher than for 90% to 95% LTV products.
Freddie made a similar change back in 2011 "to support responsible lending and sustainable homeownership," according to a bulletin issued that year.
The Department of Housing and Urban Development helps borrowers obtain loans by facilitating down payments as low as 3.5% through the Federal Housing Administration. But lenders and borrowers have been concerned about these loans' rising costs due to insurance premium hikes, among other things. Like Freddie and Fannie, the FHA once had a 3% minimum down payment. It increased this by half a percentage point in 2009.
Managing low down payment risk can be expensive in part because of required data and analysis, Patricia McClung, director of program development at HUD, told attendees at the Mortgage Bankers Association's recent secondary market conference.
Valuation risks are particularly important to size up carefully because appraisals by nature are "judgmental," she says. The FHA and the GSEs have been working on improving their appraisal data operations.
Appraisals are one of the most important factors in sizing up risk when it comes to low down payment lending, according to Showalter, who spoke on the same panel as McClung.
Data flaws as a result of manufacturing mistakes may be higher in this area than many market participants think, he says. One out of seven appraisal values may have a material error, a Digital Risk comparison of data on more than 200,000 loans from multiple clients' origination systems suggests. Digital Risk compared the data to estimates derived from the application of a valuation error detection tool, an automated valuation model and a forensic audit.
Most market participants put the chance of material error at a much lower percentage rate, around 2%, Radian's Pressman says. It is possible that there is a higher percentage of manufacturing risk unrelated to fraud, she says. This is less of a concern as far as mortgage insurance coverage because it does not trigger a rescission, a Radian spokeswoman says.
Origination systems do their best to offer links that help validate data but some are better than others and clients choose the extent to which they will use these tools, says Rob Pommier, senior vice president at West Palm Beach, Fla.-based origination system and pricing engine company OpenClose. "Each client will interpret the law and level of risk associated with that," he says.