Easing within the mortgage insurance industry could allow borrowers to purchase a home with a down payment as low as 3%. Most lenders stopped offering low-down-payment mortgages after the housing market tanked. But there are signs within the industry that they are making a comeback.
Here’s exhibit ‘A’: One of the largest mortgage insurance companies in the U.S. said it will now insure loans with a loan-to-value (LTV) ratio up to 97%. Inversely, that means they would back loans with a 3% down payment.
3% Down Payments Common During Housing Boom
When the housing market was booming, circa 2000 – 2005, lenders commonly offered 3% down-payment mortgage loans. In fact, some didn’t require borrowers to have any skin in the game at all.
Credit was a lot easier to come by back then. No down payment? No problem. Bad credit? No worries. Can’t prove your income and assets with documentation. Who cares? Those were the days of anything-goes mortgage lending. Thankfully, those days are gone.
Borrowers Needed More ‘Skin in the Game’ in Post-Crisis Years
We now know there is a statistical correlation between the size of a borrower’s down payment and the likelihood of default. In short, home buyers who make smaller down payments (0% – 5%) are more likely to default on their loans. So it’s easy to understand why most lenders stopped offering 3% down payments, or LTV ratios of 97%, when the bottom fell out of the market.
Low down payments came under fire in the post-crisis years. When federal regulators first started crafting their qualified residential mortgage (QRM) rule, they entertained the idea of requiring a 20% down payment. According to Paul Willen, a policy adviser at the Federal Reserve Bank of Boston: “If our goal is to prevent foreclosures, I can’t think of anything more effective than requiring a down payment.”
Regulators have since backed away from the 20% proposal. The latest QRM proposal does not have an LTV or down-payment component, which is good news for borrowers with limited funds.
Mortgage Insurance Company MGIC Allowing 97% LTV
Lately, we have been seeing signs of increased confidence in the lending industry. Some mortgage lenders have been easing their standards for borrowers, putting home loans within reach of more Americans. Just yesterday, we reported that JPMorgan Chase and Co., one of the largest lenders in the country, lowered its down-payment requirements for Florida borrowers.
Here’s another sign of change within the industry. MGIC Investment Corp., which calls itself the largest mortgage insurance company in the U.S., recently changed one of their rules regarding down payments and loan-to-value ratios. According to a recent Bloomberg story, borrowers with credit scores of 620 or higher and LTV ratios up to 97% can now qualify for private mortgage insurance (PMI) through MGIC. As a result, more lenders may start offering home loans with 3% down payments.
According to Sal Miosi, vice president of MGIC, the company’s previously stiffer rules “weren’t contributing to the credit quality [of loans], they were just adding to complexity.”
Fannie Mae Still Wary of 3% Down Payments
The secondary mortgage market plays a huge role in all of this. On the conventional side, the lending industry is primarily influenced by three groups. Lenders make the loans. Private mortgage insurance companies like MGIC insure the loans. Entities like Fannie Mae and Freddie Mac purchase the loans and sell them to investors in the form of mortgage-backed securities (MBS).
What does this have to do with 3% down payments? Plenty. If the government-controlled juggernauts Fannie and Freddie do not purchase a certain type of loan, lenders are less likely to offer it. That’s because lenders generally prefer to sell their loans into the secondary market, thereby reducing their long-term exposure.
Fannie Mae officials recently said they are reviewing their policies regarding the purchase of loans with 3% down payments. The company may soon curtail their purchase of such loans, which would make lenders less likely to originate them in the first place.
Fannie Mae continued to accept 3% down-payment mortgages, even during the housing crisis when most lenders stopped offering them. But with MGIC (and possibly other) mortgage insurers easing their standards, Fannie Mae could see a significant increase in these mortgages. In fact, it was an uptick of these loans that prompted them to review their policies in the first place.
According to a recent Wall Street Journal piece by Nick Timiraos:
“Fannie never stopped accepting purchases of loans with 3% down payments, even after lending standards were ratcheted up following the housing bust. But many lenders stopped offering them, in part because they weren’t able to obtain mortgage insurance for those loans, which Fannie requires.”
Freddie Mac currently requires a minimum down payment of 5% on the loans it will purchase.