It's not easy to find a subject upon which politicians are almost universally agreed, but the need to reform the mortgage market is one of them. Of course, lawmakers are hopelessly divided on the shape of the changes they'd like to see, and that division may yet see moves to improve the current system trapped in the legislative gridlock that has been a hallmark of recent congresses.
Nevertheless, some developments seem close to inevitable, and one that is likely to affect those who plan to buy their first home -- or who want to move while they still have limited equity in their current home -- is a proposal that might well see increases in minimum down-payment requirements.
The down-payment problem arose, as so many did, from the credit crunch. Writing for the Brookings Institution on August 6, Harvard Business School senior lecturer Robert C. Pozen recalled the thinking behind the Dodd-Frank Act, which came into effect in 2010. You may remember that part of 2007/08's financial disaster arose from the practice of mortgage lenders of immediately bundling up their liabilities and selling them on in the form of mortgage-backed securities or collateralized debt obligations. This removed any incentive from those lenders to worry at all about their borrowers' abilities to make payments. Once the debt was sold on, the mortgage companies were left with clean slates and had no reason to be concerned about how their loans performed.
So Dodd-Frank forced lenders to keep at least 5 percent of each mortgage on their own books, and this "risk retention" gave them skin in the game. However, the act also allowed exceptions, including all home loans sold on to Freddie Mac and Fannie Mae, and all that met the criteria for "qualified residential mortgages." Now there are proposals to eliminate that risk-retention rule and to allow lenders to again dispose of 100 percent of their liabilities. As Robert Pozen argues:
"If we are going to waive this risk-retention requirement for a broad array of home mortgages, we should make sure that the borrowers make a relatively large down payment. A large down payment by the borrower is the best way to reduce mortgage defaults without a risk-retention requirement for the lender."
Meanwhile, on August 6, President Obama gave a speech in which he backed Senate plans to wind down Freddie Mac and Fannie Mae. According to a New York Times report, he said:
"First, private capital should take a bigger role in the mortgage markets… I believe that our housing system should operate where there's a limited government role, and private lending should be the backbone of the housing market."
If the federal government were to withdraw from its role as the effective guarantor -- through the Federal Housing Administration (FHA) and Freddie and Fannie -- of most new home loans, then private lenders may require higher down payments. After all, their risk would be greater.
Of course, things might swing the other way. On August 1, The Oregonian reported on private lenders' increasing willingness to accommodate home buyers with limited cash for down payments. And, let's not forget it was private mortgage lenders who were offering zero-down-payment deals to sub-prime borrowers in 2006.
If you have limited funds and want to buy a home soon, you're faced with a world of uncertainty. Depending on how the mortgage market is restructured, if at all, you could find it much easier or much harder to gain a toehold on the property ladder.
However, one thing remains certain. There are very real advantages to making as big a down payment as you can because:
Indeed, The Oregonian calculated that a hypothetical borrower who scraped together a 5 percent down payment (you need only 3.5 percent for an FHA loan, and nothing for a Veterans Administration (VA) loan) on a private "conventional loan" would, after 10 years, have saved $13,500 on one backed by the FHA.
It's a lot to weigh up, but there seem to be four rules that might help you: