Should the Government or the Market Set Mortgage Down Payments? A New Study

UNC's Center for Community Capital has posted a new analysis of 19.5 million mortgage loans originated between 2000 and 2008 finding that mandatory down payments of 10% would lock out nearly 40% of all creditworthy borrowers while a 20% down payment would exclude 60%. The study finds a significantly higher exclusion rate for African American and Latino borrowers. The authors (Roberto Quercia of UNC, Lei Ding of Wayne State University, & Carolina Reid from the Center for Responsible Lending) do find valuable default-reduction benefits of other forms of strong underwriting as the Dodd-Frank Act already requires (through the "QM" and "QRM" classifications), but signal caution about the significant access costs of government-mandated down payment levels that government regulators may be currently considering.

Comments

[Russ]

Govt shouldn't set down payments. The market decides what works and what risk is tolerable.

However, it shouldn't be too much to ask for borrowers to come up with at least 5% down. I don't have issues with 100% down in some cases where there are compensating factors - higher than normal incomes but not a lot of savings which is something I often see as a lender with new Doctors, attorneys, and other graduate professionals.

[Melissa Jacoby]

Russ, Just to clarify, are you saying you think the government should mandate 5% other than exceptional circumstances? Or that lenders should on their own require more than that?

[Russ]

No, the government needs to stay out of lending and shouldn't be arbitrarily setting underwriting guidelines. It is bad enough with Fannie/Freddie right now. The last thing we need is Dodd/Frank hampering the private lenders.

[KS]

The government should be involved because private lenders have shown a clear lack of foresight and have proven that their goal is short term profits. Without some intervention, another bubble could build and at some point put another decade long damper on our economy. In my opinion, the last thing we need is another housing crisis. The government needs to find that line between harming people by being too protective and not protecting them at all.

[Jim A]

And yet....If the government is going to provide deposit insurance to banks through the FDIC, there is a duty to regulate the assets of those banks. So while the government shouldn't MANDATE any particular downpayment, they SHOULD regard mortgages with lower downpayments as less secure assets. Not to mention the fact that since taxpayers are now explicitly on the hook for whatever loans F&F buy, we have an interest in minimizing losses on those loans.

[Russ]

The problem is the government has a tendency to over do it when it comes to regulations and guidance in the housing market. If only any of you would spend a day in the front lines seeing how all these regulations create nothing but mounds of paperwork, raise costs for consumers, and hamper efficiency of the market.

I'm not saying there shouldn't be some reasonable oversight, but what happens is a complete disconnect from reality in the name of making some bureaucrat feel like they are actually doing something productive. We already have tons of regulations on the books. Instead of new ones, we just need the current ones enforced.

I just got back from a purchase closing and clients were an Architect and Doctor and couldn't easily understand the HUD-1 because of the mindless regulations that govern how they are done.

Not too mention banks running around documenting $100 deposits into checking accounts with $50,000 in it just because Fannie/Freddie have decided we need to source all funds going into accounts even if it clearly makes no sense.

Nuance, common sense, and government regulations do not go hand in hand which is the problem.

[mt]

The simple solution is to shift government assistance away from loan guarantees and mortgage interest deduction into 401K / IRA style savings accounts to save up a down payment. That way, we get better credit quality, less contingent risk on the balance sheet of the government, yet people can get to where they need to get in terms of a downpayment faster.

[Thomas Wicklund]

In principle I would prefer that down payments be left to the market, however the financial sector has shown a real failure in assessing risk. Since the government has bailed them out, and has essentially guaranteed large financial institutions, they have some right to set down payments.

That said, the risk is that a study like the one cited above will generate political pressure to keep down payments too low, perhaps setting us up for another banking crisis if house prices fall again.

At a time when banks are being criticized for 30:1 leverage, can we justify a 3% down payment (which is essentially 30:1 leverage when purchasing a house)?