It is pretty obvious and almost goes without saying that at this point in American Real Estate, the down payment on a home is the single largest obstacle in the home buying process. And unfortunately for prospective homebuyers and the mortgage industry alike, the down payment is the first step towards homeownership, because purchasing a home is not as simple and convenient as the consumerist lifestyle fostered by the American people, so without accomplishing step one this goal is impossible to execute. Purchasing a home is not at all like heading over to the Apple store and purchasing an iPhone. Rather, it is a well thought out, thoroughly calculated transaction involving multiple people. The down payment ‘problem’ has stagnated the home buying market, leaving “DANGER” written all over the walls for people who should be purchasing homes right now and setting up this long-term investment for the benefit of their future. For all of the wanna-be homeowners out there: there is light at the end of the tunnel.
There is the common impression that there is no way a person could qualify for a mortgage without tons of cash in the bank to cover a down payment and closing costs, a perfect credit score, and no outstanding student debt. Articles and news anchors circulate the media with news stories about how mortgage-lending standards are the strictest they have ever been in decades, which doesn’t help the cause. Everyone is entitled to their own opinion, but the amount of persons under that impression who have never even tried to obtain a mortgage is striking. The Los Angeles Times notes, “A study based on a statistical sample of potential home buyers conducted earlier in the year by the mortgage company LoanDepot found that nearly 60% of people who say they want to buy a home aren’t pursuing it because they think there’s just no point — they are convinced their applications would be rejected. Three-quarters of them, however, concede that they haven’t done a thing to check out current lender requirements.” This does nothing but accentuate the power of the media. People are so wrapped up in what they hear, that they haven’t even taken the action to test whether the situation applies to them.
There are significant changes underway in the mortgage industry that could give many more prospective homebuyers both the hope and the ability to qualify for a mortgage. At the end of November 2014, mortgage giants, Fannie Mae and Freddie Mac released information about their plans to make monumental procedural changes that should encourage both lenders and borrowers alike to be more active in the market (See “Federal Housing Finance Agency Director, Mel Watt, Faces Drawback on the Prospect of 3-Percent Down Mortgages). Lenders will now be less fearful that the mortgages they approve will be subject to buybacks in the case that the borrower defaults on their mortgage payment. Buybacks are one of the many culprits for the stagnant market right now, as Fannie Mae and Freddie Mac forced many lenders to buyback mortgages in the height of the financial crises. The lender that originated the mortgages were forced to repurchase back their loans due to allegedly making mistakes in underwriting which led to the borrower’s delinquency. In order to avoid this from happening again lenders have beefed up their underwriting standards and added fees called “overlays” which have been created to compensate for any potential loss on a loan to a borrower with less than average credit scores, small down payments, and minimal assets.
The changes relieve the fear that has been instilled in the lenders for the past few years, and they also “lower” the bar for the criteria to obtain a loan. The Los Angeles Times states, “David Lowman, a Freddie Mac executive vice president, was explicit about the desired end result. The policy revisions ‘should encourage lenders to serve a broader range of qualified borrowers,’ he said. His counterpart at Fannie Mae, Andrew Bon Salle, said he expected lenders to make ‘mortgages available to more borrowers.’” NASDAQ reports that in a discussion just “last week with the Mortgage Bankers Association, Timothy Mayopoulos, CEO of Fannie Mae, elaborated on the plans that would expand the government-sponsored entity’s ability to offer low down payment mortgage options for U.S. homebuyers. For many potential borrowers, this move could be the key to making an otherwise impossible home purchase a reality”. Fannie and Freddie plan to lower the down payment requirement to 3%. Currently the minimum is 5% down. This is not hugely different from the requirement by the Federal Housing Administration (FHA), which requires only a 3.5% down payment, however, the mortgage insurance premiums on the 3.5% FHA loan are incredibly high thus making their loans more expensive than Fannie and Freddie loans. Cutting back to a 3% down payment requirement could unleash many borrowers without as much liquid capital into the market. This may require something like pre-purchase financial counseling, but that is a lot more appealing to borrowers than expensive mortgage insurance.
While there is drawback from politicians on the proposal by Fannie and Freddie, lenders and private mortgage insurers are in support of this as they stand to win. For the record, private mortgage insurance is required on all loans that the borrower has put less than 20% down. Mortgage insurance is another method of protection in the case that the loan is not repaid, as less than 20% down paints the picture of a more risky borrower. Politicians contend that there is too much risk associated with lowering the bar for borrowers to enter the market, but it may just be the exact boost that the market desperately needs at the moment. The action will qualify more first-time buyers, whom are one of the most affected markets by current lending standards. Lenders want to lend more, and they will be more confident if they know that they are following Fannie and Freddie guidelines.
Lenders need to spread awareness about the new developments in the mortgage industry. For those borrowers with the ability to obtain gifts from others, this is eligible to account for 100% of their down payment. Also, the average FICO score accepted this October has been 726 contrary to the ‘pristine’ scores than many borrowers think to be the only acceptable scores out there. FHA even takes it a step down to an average of 683 FICO.
This news is extremely significant, despite which lender a prospective homebuyer is planning on working with. The reason for this is that since the financial crisis occurred in 2008, the overwhelming majority of all home loans in the United States come with a government guarantee from one of the mortgage giants. When the banks originate a mortgage loan, they are more likely than not to sell that loan off to one of the government entities: Fannie or Freddie who bundle the sold loans into mortgage-backed securities. As the mortgage industry stands today, Fannie Mae and Freddie Mac are really the only secondary market companies available. NASDAQ contends,
“Since 2009, Fannie has purchased or guaranteed $4.3 trillion of mortgages in the U.S…..because the entire mortgage market more or less runs through Fannie, Freddie, and, to a lesser extent, the Federal Housing Administration, or FHA, buyers must qualify based on the underwriting criteria of these faceless giants. This means more often than not a 20% down payment is required. Mayapoulos explained that, for many borrowers, that 20% hurdle can be too much of an obstacle to overcome. Therefore, Fannie Mae is preparing to roll out programs that could feature down payment requirements as low as just 3%”.
Overall, a lower down payment should be a serious consideration on the part of the borrower, as there is a lot associated with it. A lower down payment may add a higher interest rate and come with mortgage insurance as discussed previously, which will raise the monthly payment requirement and could cause cash flow problems on a month-to-month basis if not properly accounted for. However, if it is properly accounted for, this could prove the substantial savings between buying and renting. Future homebuyers have a bright future ahead of them. The mortgage industry is working hard to target more credit worthy homebuyers and educate them on the benefits of becoming a homeowner. The process will be refined so that the industry picks up, while avoiding the risk of approaching another housing bubble.