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The 3% Down Payment Makes a Comeback

Federal lending giants Fannie Mae and Freddie Mac are announcing a major change in their mortgage lending requirements, and that has some housing market watchers worried. Will lower down payment requirements boost a stagnant market – or lead to another collapse?

Fannie and Freddie, two leading players in the government housing loan business, now say that they’ll back mortgages with as little as 3 percent in down payment – a step that, they hope, will stimulate borrowing and keep the housing recovery afloat. But for some, the move is too reminiscent of the kind of lending strategies that laid the groundwork for the 2008 housing crisis.

Lowering down payment standards is an effort to mitigate the unintended consequences of tightening standards after the collapse in order to prevent another one. Pre-2008, mortgage-lending standards were loose and easy. Virtually anybody could get a home loan, and banks played fast and loose with the rules to make their profits.

But those bad loans came home to roost when many of these new homeowners found themselves trapped into adjusted rate mortgages (ARMs) whose payments started out low and quickly ballooned into unmanageable debt. Foreclosures followed, and so did investigations into fraudulent and illegal lending practices on the part of the nation’s lenders, both big and small. But especially big.

The US Department of Justice launched a series of investigations into the practices of Bank of America, JP Morgan Chase, Citibank and others. Those investigations resulted in a string of lawsuits and settlements with bank customers. Eventually, too, the whole situation led to the creation of sweeping legislation to regulate the mortgage lending industry and protect consumers from the banks’ predatory practices – and themselves.

The Dodd Frank Act put in place several new regulations on lenders. Under the Qualified Mortgage Rule which took effect in early 2014, for example, lending standards for “safe” loans were tightened up substantially. That meant borrowers needed to have higher credit scores, a lower ratio of debt to income, and be able to come up with a down payment f at least 20 percent of a home’s purchase price. These minimum requirements protected banks from prosecution for making bad loans.

But a not too surprising thing happened. Fewer people were applying for mortgages. And of those who did, fewer were being approved thanks to poor credit scores and a sluggish job market that made it hard to save up for that 20% down. Home buying rates fell to their lowest levels in over two decades.

If fewer would be borrowers could qualify under the new standards, the government found a way to fix that: lower the standards. The Federal Reserve took the unprecedented step of asking the Fair Isaac Corporation, the entity responsible for the FICO credit scoring system, to discount some blots such as home foreclosures, and to lower the points awarded for certain kinds of credit problems. Lenders themselves opened their doors to borrowers with previous foreclosures and other kinds of problems. Amendments to the QM Rule allowed for higher debt to income ratios and the option of lower down payments in some circumstances.

Now, Fannie Mae and Freddie Mac have joined the move to lower standards by agreeing to underwrite mortgages with just 3 percent down in an effort to attract more first time home buyers and boosting the slowing housing market.

The low down payment option isn’t available to everyone. Borrowers still need to demonstrate good credit and meet income requirements. But by allowing the lower down payment, Fannie and Freddie are removing one major obstacle facing first time homebuyers, who may meet all the other requirements but still lack the available cash to make 20 percent down.

Still, some financial experts worry that if borrowers can’t even make the standard down payment, they may well be at risk for defaulting later on. And that could lead to another massive wave of home foreclosures, just like the last round.

But federal officials say that the lending climate is very different today. More consumer safeguards are in place and the lending industry is more accountable than in the past. Today’s borrowers are still held to a higher standard even with the lower down payment options, too.

The decision by Fannie Mae and Freddie Mac is only one of several moves to tweak today’s higher standards for mortgage lending, and it’s unclear yet whether any of these measures will boost home buying in an era when many Americans just aren’t interested in buying a house. But those measures might breathe new life into the housing sector, with benefits for investors building wealth through income property, as Jason Hartman recommends.  (Featured image:Flickr/drstarbucks)


Gidman, Jenn. “The 3% Mortgage Down Payment is Back.” Newser. newser.com. 9 Dec 2014

Read more from Heroic Investing:

New Real Estate Scam Shows Red Flags

Where Have All the Mortgages Gone?

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