Federal Housing Finance Agency Director Melvin Watt’s decision to lower down payments from the previous 5% to 3% has received criticism from the House Financial Services Committee (HFSC). Committee members claim that Watt’s decision, which allows both Freddie Mac and Fannie Mae to purchase loans with lower down payments, has the potential to lead to another lending crisis due to risky lending practices. However, if you consider the other factors of providing credit, Watt and others believe that this just is not the case.
Down Payments a Major Factor in Home Ownership
For many would-be homeowners, high down payments are often a major factor in their ability to actually purchase their own homes. According to Moebs Services, Inc., a bank consulting firm, the average balance for checking accounts in the United States over the past 25 years was around $1,400. However, at the end of 2014, the firm determined that this amount had risen to around $4,400. When you consider that the standard 20% down payment for a $100,000 home is $20,000, it’s easy to see why so many struggle to achieve the dream of owning their own homes. With the changes in place for low down payment loans, this amount drops to $3,000, which greatly increases the number of people who may finally be able to purchase their own home.
Other Factors Influence Risk
While opponents of the 3% down payment argue that the decrease increases the risk of a repeat of the housing crisis significantly, Watt and proponents of the decrease say that this isn’t the case. Instead, they claim that the most important factors that influence risk are:
- Credit score
- Monetary reserves
Watt and others say that the previous crisis was due to the combination of low down payments, a decrease in the required credit scores, and other risk factors, rather than simply lower down payments. Some experts cite that when these factors are controlled, the actual risk of low down payments becomes considerably lower.
Koss also points out that allowing new homeowners to keep more cash in reserve, rather than using it all up for the down payment, leads to decreased risk for lenders. Even though the lender receives less up front to secure the loan, the ability for borrowers to have extra savings put back provides a cushion that can help reduce the chances of defaulting. This savings can be put to use paying the mortgage if something happens that affects the borrower’s income, providing them with valuable time to return to their loan-qualifying income. However, this is not the only factor that decreases risk.
Improved Quality Control
Quality control will play a major role in decreasing the risk of lower down payments, as it will focus on making sure that the other factors in the pre-qualification process are met. McCall points out that the decrease in down payments will require lenders to make sure they are paying close attention to adhering to the other requirements, such as credit score and ability to pay. By instituting these types of quality control, lenders will be able to make sure they are making accurate lending decisions.
Watt’s decision to lower down payments increases the ability for renters to become homeowners. As long as lenders pay attention to the other factors of qualifying for these loans, including making sure that the borrowers meet the income and credit score requirements, the decrease does not increase risk. Instead, it increases the ability of lenders to enter into quality loans based on actual ability to pay, rather than focusing on what a potential borrower may be able to save.
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