The Low Down on Low Down Payment Mortgages: Is It Safe?

Abstract

Low down payment mortgages were prevalent before the financial crisis, slowed down during the financial crisis, but have reemerged since the financial crisis. The Federal Housing Administration has a history of insuring 3% down payment mortgages to help lower- and middle-income households purchase a home, but Fannie Mae and Freddie Mac recently have introduced 3% (and lower) down payment programs. In addition, mortgage innovation in the form of the “wealth building mortgage” now adds the possibility of a 100% loan-to-value (LTV) ratio. In this paper, we examine the performance of low down payment (or high LTV) lending. We find that low initial down payment mortgages are significantly more likely to become seriously delinquent (90 days or more) than mortgages with traditional down payments of 20% or more.

TOPICS: Fixed income and structured finance, MBS and residential mortgage loans, risk management, credit risk management, legal/regulatory/public policy, financial crises and financial market history

Key Findings

• ▪ This study finds meaningfully accurate estimates of the likelihood of more severe delinquency payment status changes by using individual mortgage loan, borrower, and county-level risk factors as explanatory variables.

• ▪ Low initial down payment mortgages are significantly more likely to become seriously delinquent (90 days or more) than mortgages with traditional downpayments of 20% or more.

• ▪ Initial borrower and mortgage characteristics, such as LTV, borrower documentation, or FICO score, are dominant factors in the likelihood of delinquency and default.