By Steve Cook

 

Aint this a great nation?

Not so long ago federal housing policies were judged by their ability to require lenders to put “skin in the game”—to require make a large enough down payment to discourage defaults.

Now, the FHFA has decided Fannie Mae will accept a 3 percent down payment for highly qualified borrowers to help first-time buyers and breathe life into the flagging housing economy.

To explain this dichotomy, the Urban Institute has released a review of the performance of low-down-payment GSE mortgages in recent years.  It seems now that low down loans were always a good idea.  It’s just that late last year, when the skin-in-the-game folks succeeded in raising the GSE minimum down payment to at least 5 percent, lower down payment were politically incorrect.

The default rates of 3-5 and 5-10 percent-down payment GSE loans are similar, the Urban Institute expert found.  Loans that originated in recent years with down payments between 3-5 percent exhibit default rates similar to the default rates of those with slightly larger down payments—in the 90-95 LTV category.

Of loans that originated in 2011 with a down payment between 3-5 percent, only 0.4 percent of borrowers have defaulted. For loans with slightly larger down payments—between 5-10 percent—the default rate was exactly the same. The story is similar for loans made in 2012, with 0.2 percent in the 3-5 percent down-payment group defaulting, versus 0.1 percent of loans in the 5-10 percent down-payment group.  The study was limited to 30-year, fixed-rate, amortizing mortgages (interest-only mortgages, 40-year mortgages, and negative-amortization loans are excluded).

Moreover, the study found that borrower’s credit is a stronger indicator of default risk than down payment size with these loans.  The pattern is consistent even in the years leading up to the crisis, when overall default rates were much higher. In 2007, the worst issue year, 95-97 LTV loans in any given FICO bucket performed only marginally worse than the 90-95 LTV loans, and FICO score was a larger determinant of performance. For example, 95-97 LTV loans with a 700-750 FICO score have a default rate of 21.3 percent, versus 18.2 percent for 90-95 LTV loans. However, the 95-97 LTV loans with a FICO score above 750 had a 13.5 percent default rate, much lower than the 90-95 LTV loans with a 700-750 FICO score.

Apparently the study was based on the two-generation old FICO scoring system that the GSEs are using, not the newest FICO model, which reduces the negative impact of medical debt.

“This analysis tells us that there is likely to be minimal impact on default rates as low-down payment GSE lending gravitates towards borrowers with otherwise strong credit profiles.  And this makes sense because GSE loans are priced on the basis of risk (including loan-level pricing adjustment and mortgage insurance costs), while Federal Housing Authority (FHA) loans are not. Thus, borrowers with high LTVs and low FICO scores will find it more economically favorable to obtain an FHA loan,” the study concluded.

Question:  If it makes so much sense now, why didn’t it make sense a year ago before thousands of prospective buyers learned they needed 5 percent or more for a conforming loan unless they chose the FHA route, which would probably cost them more in mortgage insurance premiums than they would save on a down payment?

Skin in the game or skinned in the game?