The Disappearing Little-Down Mortgages Magic Trick

Will 30-year mortgages with little down soon be a pleasant memory, something older folks will recall along with floppy disks and disco balls?

“Many housing proponents say that it will,” reports Lew Sichelman, writing in the Los Angeles Times. “Without the government’s backing, they contend that the 30-year mortgage will become a relic of a bygone era when mortgage money was cheap and easy to come by. But others say America’s most popular home loan will still be available — if you can afford it.”
But is the choice really no 30-year mortgage or super-expensive long-term financing? And if 30-year loans vanish, what will happen to the real estate marketplace?

Wall Street Reform
We generally describe a conventional loan as 15- or 30-year self-amortizing financing with 20 percent down. The down payment can be in the form of 20 percent in cash or far less down for borrowers who get mortgage insurance, protection for the lender in case the loan is foreclosed.

Under Dodd-Frank Wall Street Reform and Consumer Protection Act passed in the summer of 2010, there are new requirements for most mortgages. For instance, income and employment must be documented; points and fees can total no more than 3 percent of the loan amount; and ARM borrowers must be qualified on the basis of the highest possible loan costs they will face during the first five years of the loan.

Wall Street reform also has a tough down payment standard: With some exceptions, borrowers will need 20 percent down plus closing costs. Mortgage insurance cannot be used to reduce the necessary down payment.
“One of the most damaging proposals would effectively raise down payment requirements to 20 percent, which would slam the brakes on the housing market,” said Ron Phipps, president of the National Association of Realtors.

The down payment requirement sets off two concerns: First, most borrowers do not have 20 percent down much less 20 percent down plus closing costs. Second, to avoid increased liability and a 5 percent reserve requirement, lenders want to make loans which meet the “qualified mortgage” definitions contained in the Wall Street reform measure. The result is that home sales and refinancing could plummet if the 20 percent down requirement became widespread.

While much has been made of the 20 percent down requirement, the “exceptions” have largely been overlooked. In fact, most loans today are excluded from the 20 percent down standard:

  • Conventional loans purchased by Fannie Mae and Freddie Mac.
  • Mortgages insured by the FHA.
  • VA-insured loans.
  • Loans held by lenders in their portfolios and not intended for sale on the secondary market.

The market share of these exceptions is enormous. Indeed, most loans today are bought with little down. According to the National Association of Realtors, the typical down payment was 14 percent for repeat buyers in 2010 — and just 4 percent for first-time purchasers.
Tomorrow’s Loans
But if huge numbers of loans are exempt from the 20 percent down requirement then what’s the big deal?

The answer concerns not so much the current marketplace as the mortgage market of the future. One explanation comes from Richard Andreano, an attorney with the Washington law firm of Patton Boggs.

“As proposed, there is an exemption from risk retention for FHA and VA loans, so those lower down payment programs will still be available. However, the FHA loan limit is scheduled to decrease to normal levels on October 1, and the government overall is assessing the role of the federal government, including FHA, in the mortgage market.
“The proposed exemption for Fannie/Freddie securities has generated opposition, as it is not provided for in Dodd-Frank and to some appears contrary to the government’s intention to wind down the operations of Fannie and Freddie. Even if adopted, the exemption will have a limited life because it will last only while Fannie/Freddie are in conservatorship or receivership and have capital support from the United States (or during the existence of any limited-life regulatory entity that succeeds to Fannie/Freddie that has capital support from the United States).

“For these reasons, the industry views the potential loss of conventional lower down payment loans to pose a real threat to homeownership.”
Fannie Mae & Freddie Mac
There’s been a lot of talk regarding an end to Fannie Mae and Freddie Mac, companies now under government control that buy local mortgages and turn them into securities for sale to investors worldwide. These government-sponsored enterprises, or GSEs, are the dominant players in the secondary market, the electronic bazaar where mortgage-backed securities are bought and sold worldwide.

For instance, HR 1859, the Housing Finance Reform Act of 2011, would replace Fannie Mae and Freddie Mac with at least privately held housing finance guaranty associations that would operate with insurance guarantees from the government. In effect, the associations would somewhat parallel private-sector banks with FDIC insurance for depositors.

“This is a reasonable, bipartisan approach to achieving two key goals: putting an end to taxpayer-funded bailouts and ensuring that responsible, middle class families can still achieve the dream of homeownership,” said co-sponsor Rep. Gary Peters (D-MI). “The status quo is unacceptable, but eliminating any government role in the mortgage market would undermine the fragile housing recovery and essentially eliminate the 30-year fixed rate mortgage.”

The catch is that dumping Fannie Mae and Freddie Mac is hardly a done deal.

First, mortgage rates would likely rise.

“While this route would not add liabilities to the government balance sheet, the transition to a private mortgage finance market would involve a massive shift in resources and infrastructure from GSEs and other government institutions to private enterprise,” according to Smith Breeden Associates, a specialist in mortgage-backed securities (MBS). “This would certainly raise mortgage rates in the short- to intermediate-term, and likely jeopardize the current housing recovery, which could potentially derail the overall economic recovery.”

Second, not everyone is thrilled with a few private entities replacing Fannie Mae and Freddie Mac. The politically potent Independent Community Bankers of America favors a different approach.
“In a cooperative model,” writes the ICBA, “Fannie Mae and Freddie Mac would be replaced by co-ops owned by lenders that originate residential mortgages for sale into the secondary market and governed on a one-company-one-vote basis. Cooperative ownership would ensure that the entities are not driven by quarterly earnings or dividends. Access for smaller lenders would promote a competitive market for credit and deter further industry consolidation.”
Third, there’s an international aspect to the replacement issue. Mortgage-backed securities are sold worldwide and to accept today’s rates investors would not want anything short of the federal guarantees they now have with Fannie Mae and Freddie Mac. Moreover, if the secondary market is to be dominated by private players, foreign investors who supply some of the cash that powers the system will surely ask why those players should be limited to U.S. interests.

30-Year Mortgages
“For those who want to buy or refinance real estate the only issue with Wall Street reform is the continued availability of 30-year, fixed-rate mortgages with low interest levels and as little down as possible,” said James J. Saccacio, chief executive officer of RealtyTrac. “Many of the new loan standards parallel traditional requirements for prudent lending. In a sense, we’re going back a decade or two to assure stability in the mortgage marketplace.”
In the end, loans with little down will continue to be widely available. The reason is fairly plain: Without such financing the housing market will freeze; it won’t matter who dominates the secondary market, and the impact of a stalled housing system will echo throughout the economy — and not in a good way.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site,  

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