The Changing Lending Environment

Good article... providing perspective over time

Higher Down Payments May Be the New Norm.... (Published on 3/28/11)  by Preston Howard



Preston Howard

At the height of the mortgage boom, required down payments were at an all time low. In June of 2006, the average down payment percentage on the purchase of a single family residence was 4%. If you had good credit and a heartbeat, there were lenders who would provide you with a 100% loan with no documentation outside of your name, address, and Social Security Number. Now, all of that is about to change. Serious talk is being floated around Washington D.C. that the return of the days of a minimum of 10% and an average down payment of 20% is swiftly approaching.

The Obama Administration has called for 10% minimums on Fannie/Freddie loans. Sheila Bair, Chairwoman of the FDIC has stated that she flat out wants 20% down payments. Many banks are already there. An analysis of major metropolitan areas reveals that the current average down payment is at 22%. Much of this is driven by the large commercial banks pushing for higher down payments to stem their losses and discourage delinquencies with borrowers having “more skin in the game.” In addition, this is also a form of pre-emptive planning as housing prices continue to fall. The thought is that lower leverage equals lower risk. This conventional wisdom holds true in the majority of cases as most property owners are less likely to walk away from a property in which they have made a significant investment. However, what happens to the individual who wants the “American dream” but no capital? Their option will most likely be a government agency.

As previously mentioned, Fannie/Freddie will require 10%. That’s half of the new norm, but depending on who you are and your price maximum, that’s still a lot of money. Then, there is the FHA and the VA. They have seen a lot of action over the last 2.5 years. In 2009/2010, 50% of all mortgages originated were made with FHA guaranteed funds. The caveat is that FHA funds have various financial handcuffs, e.g. tax impounds, forced insurance, upfront MIP fees, and higher interest rates. If a borrower puts down 20% or more on a non-government backed loan, the rates are usually lower, impounds aren’t required, and mortgage insurance is illegal. Essentially, a new “sub-prime” market is being created whereby those without sufficient down payments are forced to pay extra fees and incur higher rates, or continue renting.

These actions have resulted in the financial world of two extremes: those with a 20% down payment who get all of the perks, and those without the capital who get all of the fees. I foresee a great demand for something in the middle to be created. It may take some time to materialize as the methods of filling the void in the past have faltered. Mezzanine financing above 80% CLTV is currently non-existent. Currently, cities are broke so the availability of the Housing Finance Agency’s “silent seconds” is scarce. The private market hasn’t been incentivized to fill the gap, so the void with the need to be filled will remain, and hard money is too expensive. I believe that if the American public was aware and takes a close look at this new reality, protests will ensue, lobbying will occur and something will be done, as the “charges for some, but not for all” mantra can’t continue for too long. Eventually, a product or solution will be produced, as the margin between 3.5% and 20% is too wide, the demand is heavy and the pending increases in Fannie/Freddie costs are too real.

Preston Howard is a mortgage broker and Principal of Rose City Realty, Inc. in Pasadena, CA. Specializing in various facets of real estate finance, he can be reached at howardpr@rosecityrealtyinc.com.