C&B Notes

Eroding Mortgage Standards

Much like fixed income investors in corporate bonds have been willing to accept more risk through weaker covenants to chase what little yield remains, mortgage underwriters are willingly lowering down payment standards to attract more borrowers.  Unlike corporate bond buyers, these originators are often backstopped by Fannie Mae and Freddie Mac, who have promoted these risk-generating requirements by lowering minimum down payments in recent weeks.  Compounding the inherent principal-agent problem, the worse loan-to-value ratio both increases payments, which means borrowers have less room for error in terms of their monthly cash flow, and makes full loan recovery harder in the event of default for the lender and/or mortgage insurer.  While this move may stimulate mortgage demand and increase fees for brokers and banks, it sure smells a lot like the mid-2000’s.

It is getting easier for some buyers to land a house with less money up front.  More lenders are lowering down-payment requirements, allowing borrowers to commit 3% – or even less – of a home’s purchase price to get a mortgage.  Most had been requiring down payments of 20% or more since the recession began, with a few exceptions.  Some lenders also are waiving mortgage-related fees, and more are allowing down payments to be made by other parties, such as the borrower’s family.  The deals are aimed at buyers with good credit scores and a steady income who have been unable to save enough for a sizable down payment.  They are often targeted at buyers who live in expensive housing markets, where even a small down payment can equal tens of thousands of dollars.

The trend toward lower down payments has picked up since mortgage-finance giants Fannie Mae and Freddie Mac, which buy most mortgages from lenders, recently lowered the minimum down payments they will accept to 3% from 5%.  The changes are driven by an Obama administration effort to make homeownership affordable to a wider group of buyers…

Borrowers should be aware that small down payments leave them more at risk of owing more on their mortgage than the property is worth should home values in their market decline, says Jack McCabe, an independent housing analyst in Deerfield Beach, Fla.  In addition, borrowers likely will incur higher costs over the life of the loan, including higher interest rates and, often, mortgage insurance.

The moves come as mortgage originations declined substantially last year.  Lenders gave out an estimated $1.12 trillion in mortgages in 2014, down 39% from a year earlier and the lowest amount since 1997, according to the Mortgage Bankers Association, a Washington-based trade group.