A Low-Down-Payment Mortgage Isn't What We Need Right Now

The financial services industry is on the verge of an awesome hat trick with regard to residential mortgages.

For the uninitiated, hat trick is sports-speak for three goals that are scored by the same player in a single game. In this instance, the trick revolves around three rather significant concessions the Federal Housing Finance Agency—the regulatory body for Fannie Mae and Freddie Mac—appears to be ready to make.

The first has to do with minimum down-payment requirements.

Soon after the economic collapse that many rightly attribute to recklessly-relaxed underwriting standards that led to the bailout of Fannie and Freddie, the FHFA tightened up its lending criteria for residential mortgage loans. But as the housing market continues to sputter and lenders are reluctant to work with purchasers who are unable to meet their own underwriting requirements, the regulators blinked.

In a series of steps, the FHFA has eased up on the 20% down payment requirement to as little as 3% for qualifying first-time buyers; the same consumers who also happen to be especially vulnerable to low-down-payment schemes.

But that doesn’t seem to bother the financial services industry—not when 95% of the loans it originates are sold to Fannie and Freddie, and thus guaranteed by the government.

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So if the feds want to see the housing market recover and the lenders want to curtail what they view as excessive regulatory interference, then a good way to get what the industry wants would be to hold the line on tough underwriting standards until the feds cry uncle.

Good Debts vs. Bad Debts

The second concession has to do with the so-called representations and warranties the lenders are required to make as it pertains to ensuring the quality of the loans they sell to Fannie and Freddie—that the loans were properly underwritten, the value of the real estate is true and correct, and so forth.

The government has already recovered all its bailout money, thanks to Fannie’s and Freddie’s earnings now that the enterprises have become the lenders of record for residential mortgages. And also because the feds forced lenders to repurchase contracts that were misrepresented for one reason or another.

The industry has had more than enough of that, thank you very much—yet another reason why credit approvals may be hard to come by.

Once again, the FHFA appears to have caved, given the announcement that it plans to “revise and clarify” its framework for assuring the quality of the contracts it accepts. Specifically, the regulatory body will permit Fannie and Freddie to accept loans that may have experienced “some” delinquency within its first three years, where before that would have made the contracts ineligible for purchase. More important, the FHFA also plans to set a threshold for the number of misrepresented loans that would force the originating lenders to repurchase them, as well as to establish a means for determining whether those lapses are indeed significant enough for that to occur.

In other words, a handful of moderate dollar-value frauds with a small “f” would be OK.

Clearly, the smart strategy here would be to limit approvals on these deals until the feds come to their senses.

Who’s Minding the Store?

The last final concession has to do with the extent to which the feds plan to rely on the financial services industry to police its own compliance. Sure, Fannie and Freddie will review the reports the lenders submit to them, but they will only spot-check representative samples of the files it receives; only then would it act if the errors breach the aforementioned thresholds.

What does all of this mean for homebuyers? Let the good times roll!—at least until the next crisis. But for those who view home ownership as something other than a trip to the casino, it would be wise to take two things into thoughtful consideration.

The first is that housing—whether owned or rented—satisfies our fundamental need for shelter. I would therefore argue that home ownership is more a consumption than an investment good, and should therefore be evaluated more in terms of affordability than for its potential to yield a financial return. Of course it’s possible to hit the cycles at just the right times by buying low and selling high, but over the extended period the hope should be that a home’s value—residential improvements taken into account—will do no worse than to track the rate of inflation.

The second is related to the first. In a rising market that’s being actively supported by easy credit, gauging affordability can be subjective—like stepping on a bathroom scale in just the right way to shave a few pounds. In this case, financial engineering is the culprit. Lower down payments will translate into higher loan balances, and higher loan balances can be made more affordable by manipulating repayment terms and interest rates.

At the moment, 30-year mortgages continue to be the norm. But 40-year loans (and longer) are creeping into the market. That’s because the longer the repayment duration, the lower the monthly payment. But at the same time, the longer the duration, the higher the cost, as interest is charged against a more slowly declining principal balance.

If you can’t make the payments work within the confines of a 30-year term, it’s time to consider more money down or a less expensive property.

As for interest rates, despite the fact that we continue to be at or near an historical bottom for fixed-rate loans, adjustable-rate mortgages are making a comeback. That may be fine in a stable rate environment over an extended period, but it can be fatal to household budgets in a rising market.

Here too, if you can’t make the payments work on a conventional (fixed-rate, 30-year) mortgage, perhaps you should reconsider your plan. And if for whatever reason a conventional mortgage isn’t available, it would be wise to test the ability of your budget to withstand a worst-case scenario adjustment.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.