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Home Publications Blogs Beat the Press Poor Case for Low Down Payment Loans

Poor Case for Low Down Payment Loans

Wednesday, 24 April 2013 14:15

One of the big issues left to be resolved in the debate over housing finance is the size of the down payment that homebuyers must put down in order for a mortgage to be considered a "qualified" mortgage. If a mortgage fits this definition, securitizers would not be required to hold capital against the mortgage.

NYT's Dealbook had a post discussing the topic which highlighted research by Roberto G. Quercia, director of the Center for Community Capital at the University of North Carolina at Chapel Hill, which purports to show that there is not much additional risk of default with lower down payments. In fact, the numbers presented in the piece imply that Quercia's research implies that low down payment loans have far higher risks of default. This means that lenders would either have to charge considerably higher interest rates or be subsidized for making these loans.

The NYT piece reports that Quercia found that the default rate during the years of the housing crash on a set of loans that met certain quality standards was 5.8 percent. However the default rate on loans with down payments of 20 percent or more was just 3.9 percent.

The piece reports that this higher down payment group comprised less than half of the loans in the study. If we assume that the 20 percent down payment group comprised 40 percent of the loans then this means that the default rate for home buyers putting less than 20 percent down was over 7.0 percent, more than 80 percent higher than for the 20 percent down payment group.

Furthermore, the losses for the less than 20 percent down payment group would be considerably higher on each default since there is less of a down payment cushion. If the loss for a default on a 20 percent down payment averages 25 percent, and we assume that the average down payment for the less than 20 percent group is 10 percent, then the losses for this group would average 39 percent of the amount loaned. (A 20 percent down payment is 25 percent of mortgage loan. A 10 percent down payment is just 11 percent of the amount loaned.)

Multiplying the increased probability of default (1.8) by the higher loss per default (1.6), the cost of default for the less than 20 percent down payment mortgages would be over 180 percent higher for the more than 20 percent down payment group, according to Quercia's research. That would not seem to be a good argument to apply the same lending standards for this low down payment group.

It is also worth noting that Quercia's assessment, as presented in the NYT post, that the 20 percent down payment would have excluded more than half of the borrowers does not follow from the evidence presented. If homebuyers knew that they had to put down 20 percent to get a lower cost mortgage, then they would be more likely to have a 20 percent down payment than in a context where this was not a requirement, as was true for the period examined by Quercia.  

Comments (13)Add Comment
Another quibble
written by Mark Brucker, April 24, 2013 4:16
"It is also worth noting that Quercia's assessment, as presented in the NYT post, that the 20 percent down payment would have excluded more than half of the borrowers does not follow from the evidence presented. If homebuyers knew that they had to put down 20 percent to get a lower cost mortgage, then they would be more likely to have a 20 percent down payment than in a context where this was not a requirement, as was true for the period examined by Quercia." They also would be likely to choose less expensive homes, which would also help reduce loss problems for them and lenders. And probably reduce ongoing costs as well, which would even further reduce problems!
what is the loss with zero down?
written by pete, April 24, 2013 4:57
Mortgages are non recourse. Strategically walking away from a house whose value has fallen is much more tempting when there is zero down than when one has sunk 20% into the house. Thus losses for defaulting when there has been a down payment are higher, no?

Example 1: I buy a $400,000 house, putting in $80,000 and taking a $320,000 loan. Value of the house falls to $250,000. I walk away and lose $80,000.

Example 2: I buy a $400,000 house with no money down, taking out a $400,000 loan. House falls to $250,000. I walk away and lose....nuthing. Hmm.
Re: what is the loss with zero down?
written by Odysseus, April 24, 2013 6:00
"Mortgages are non recourse."

This is not true. Most states in the United States have recourse mortgages.
written by watermelonpunch, April 24, 2013 6:54
Does this research break down the data into "purpose of purchase"?
Not sure if that's relevant or not to this topic, but I think it would be interesting to know the data on that.
written by denise, April 24, 2013 6:57
The housing bubble and resulting problems will never happen again, of course, so we don't need to worry about that. It was just a one-time fluke.

Are we able to profit from experience at all?
written by Mark jamison, April 24, 2013 7:04
There are certainly questions that should be raised by low down payment loans but focusing on them is something of a distraction. First, low down payment loans also require private mortgage insurance. This additional cost may lead to more defaults but it also provides insurance.
The problem during the bubble was a combination of wildly inflated prices, loan securitization s that didn't accurately reflect risks, and what amounted to fraudulent marketing practices - no doc loans, pushing people into subprimes with egregious resets and other industry tactics.
Focusing on low down payment loans seems like the wrong strategy. Yes, flippers and others used these sorts of loans in ways that shouldn't have happened but let's not penalize everyone when there are ways to sort out the speculators. There circumstances when a low down payment, perhaps backed by a VA guarantee and sufficient income, is a valid way to get people into a house.
Let's ffocus on the bigger problems which include industry marketing tactics, rent seeking behaviors behind some of the fee structures, and mortgage securitization.
If 20% down were *required*...
written by Scott Dunn, April 24, 2013 10:13
...imagine the price corrections we'd see in the market. The low money down loans have helped the housing bubble to mature and have done little to actually help the economy.
We need the math done, right after we look at all mortgages....
written by EMIchael, April 25, 2013 8:22
"To underscore his point, Mr. Quercia studied mortgages in a special program for low-income borrowers, typically those with minimal down payments. From 1998 through the end of last year, 5.5 percent of the mortgages ended up in foreclosure, he found. Subprime mortgages made during the last housing boom, regardless of down payment size, had far higher foreclosure rates, roughly 25 percent."

First, who are the "low income borrowers" in this program? How did low income borrowers get 20% down? Why am I thinking Mom and Dad? Why am I thinking if Mom and Dad can fork over the down payment, they might also be able to keep their kids from default?

So the loss is "180 percent more" in the low down payment group, what is the total loss when mortgage insurance is added to the number? And why no mention of the fact that these two groups of buyers did not have the same loan as they did not qualify for the same loan? Just basic math, higher risk, higher cost.

What are the numbers when all income levels are included?

Never saw Mr. Baker with a post that raised so many questions and answered almost none.
Low down payments are not always bad
written by B Trout, April 25, 2013 10:27
Making conclusions based on the last 5 or 7 years on real estate lending is going to be misleading. The real estate meltdown and resulting recession created many scenarios we are not likely to see again. Of course a larger down payment makes for a safer loan. Lenders have known that for 50 years or more. The problem came when Wall Street came in with their own version of low down payment combined with very little risk assessment. No document loans etc. This now is banned by and act of congress. (Frank/Dodd) This act has many overcompensating factors that will slow the real estate market too much, but that is the swing of the pendulum.
written by PeonInChief, April 25, 2013 10:30
I have to take issue with Dean's assertion that people who didn't put 20% would raise it if they had to. Most first-time buyers don't put down 20% because they don't have it, and couldn't raise that much money in any reasonable period of time. (Those who do put 20% down generally do so with help from the Bank of Mom and Dad.)

And people who don't buy houses, unless they live in one of the few areas with rent control and just cause eviction can end up in the situation of some Lincoln, Nebraska tenants, where they were given 4-day eviction notices. And the evil landlord was Fannie Mae.
private mortgage insurance doesn't solve anything
written by Robert W., April 25, 2013 2:22
All PMI does is transfer the risk from the bank to the insurer. What then happens when the insurer fails due to poor loan quality? We already know the answer from the AIG fiasco; the Federal government steps in to bail out the insurer so the insured get their money back. As long as banks get to keep the profits and can pass the losses off to somebody else, they will continue to make bad loans.
C'mon Robert
written by EMIchael, April 26, 2013 8:45
AIG had absolutely no relevance to mortgage insurance, as AIG had absolutely no actuarial basis for their reserves.

Someday people will understand that the financial crisis was the cause of the housing bubble(instead of the reverse), and it was caused by the banks intentionally mispricing loans (which increased the demand for housing)while able to mis-lable their mortgages(which gave them access to cash to take their bad mortgages off the books.

Now, if you can show that the PMI in the above mortgage program was not realistic, I'll pay some attention to you. But I have a hard time believing that the 94.5% of those homeowners paying PMI was not sufficient to make the low down payment program at least as solvent as the 20% down program.
written by FoonTheElder, April 29, 2013 12:24
The government did not bail out the PMI insurers, as many of them are bankrupt.

AIG was bailed out for guaranteeing sham investments, not individual mortgage downpayments.

The bubble occurred because of corrupt practices in the mortgage industry. This was taken advantage of mostly by people who bought multiple homes and rolled them over when the bubble prices kept rising. The mortgage industry were the enablers while everyone else passed the hot potato until the eventual burning.

People who purchased and resided in their homes for less than 20% down would not have been abandoning their homes if it wasn't for shady practices and a collapsing price bubble.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.