Fannie Mae and Freddie Mac now allow mortgages with down payments as low as 3 percent.
The move provides direct competition with FHA loans. But will loosening the down payment requirements for these two mortgage giants be good for the housing market and economy? The nation’s top housing finance bigwigs can’t seem to agree.
Despite what pundits say, the program will be a boon for homeowners who just can’t save down payment funds fast enough. Conventional loans that require just 3 percent down shaves years off of a new home buyer’s saving time frame, while giving good-credit borrowers an alternative to the permanent mortgage insurance of FHA loans.
Still, it’s valuable to know the possible effects of a new, somewhat radical program. Below, we’ve outlined some of the potential benefits and pitfalls of the new 3 percent down loan.
More Eligibility for Prospective Homeowners
The U.S. homeownership rate has declined from 69.2 percent to 64.4 percent since 2004. And, the number of home purchases made by first-time buyers fell to a three-decade low just this past November, to just 33 percent, according to Realtor.org.
Most experts would agree that one reason why is that it’s become more difficult to qualify for home loans since the housing market collapse. Lenders have responded to stiff penalties, fines, and losses by imposing more stringent standards and complicated application processes that some say, perhaps were taken too far in the other direction.
As things have begun to level off, the FHFA is looking to open up the market a bit more to qualified borrowers who just happen to not have a large enough savings accumulated to make a substantial down payment. This will especially benefit minorities who often have a tough time purchasing their first home.
Critics say: There is lot of opposition, mainly from the Republicans, who say that this move puts us back on a path toward irresponsible lending. Jeb Hensarling, chairman of the House Financial Services Committee, has been the most vocal, saying in a statement (as reported by Bloomberg) that it would be a “return to slipshod and dangerous practices that caused the mortgage meltdown in the first place and wrecked our economy.”
Stricter Borrowing Requirements
Just because of a more lenient down payment requirement won’t necessarily mean it’s easier to get a Fannie or Freddie loan. In fact, once the guidelines are officially released, expect them to include that borrows must have good credit to be considered. In addition, PMI will be a no-brainer, although the terms will likely be better than that of FHA, whose mortgage insurance premiums are terribly high and non-cancellable.
Proponents of this change point out that the 2010 Dodd-Frank act (which wasn’t around back when the housing industry had all of its troubles) offers protections that will ensure borrowers could only qualify if they use no more than 43 percent of their income to pay for monthly debt.
The FHFA also cites research from the Urban Institute that found that the default rate for loans with 3 percent to 5 percent down was comparable to that of loans with 5 percent to 10 percent down. In other words, as long as the credit worthiness is assessed properly, the down payment amount shouldn’t affect the likelihood of default.
Critics say: The housing market is still trying to recoup its losses, but this program will result in more “under water” homeowners. With only 3 percent down added to closing costs, there is hardly any equity owned in the home. What will happen when interest rates rise next year (as expected), and the housing market begins to decline slightly?
Additionally, as an article in MarketWatch points out, it was only a few years back in 2008 that Fannie and Freddie began taking federal bailout funds that ultimately totaled $190 billion.
As a result, the two entities have been paying back the government since. In other words, the downfall of the housing market – despite its recent improvements – is still too fresh to be considering major policy changes, say critics. Add to that the fact that it was only one year ago that Fannie Mae raised its minimum down payment requirement from 3 to 5 percent, and Freddie hasn’t guaranteed low down payment mortgages in years. Critics might say, why the change of heart?
Competition for FHA
By getting into the 3 percent down loan business, Fannie and Freddie could offer an additional option to those who would normally have to go the FHA, VA, or USDA route. While VA and USDA loans offer some of the best terms around, FHA borrowers over the last few years have had to pay high mortgage insurance premiums. More competition could mean that buyers who comparison shop lenders will have the upper hand and some room for negotiation.
Critics say: More competition could lead to looser lending that can ultimately harm the housing finance industry, or at the very least, set back any progress it’s made over the last couple of years.
As far as buyers are concerned, having another option at their disposal could only be a good thing. Should this proposal move forward, only time will tell if it will be the boost the housing market needs, or a step backward.