Low-Down-Payment Lending: A Critical Step toward Equitable Homeownership
During the housing boom of the mid-2000s, access to mortgage finance relaxed beyond the point of common sense and good business, allowing borrowers to obtain mortgages they could not repay for homes they could not afford. The inevitable mass defaults and foreclosures that followed helped fuel the Great Recession. In the wake of the housing finance crisis, mortgage lending restricted, but just as before, it did so beyond the point of common sense and good business, producing damaging results, especially for low-income and minority families.
During subsequent reform debates, some suggested raising down payment requirements to as high as 20 percent to give borrowers sufficient “skin in the game” and deter them from defaulting on their home loans as they had done in the crisis. This focus on down payments is troubling, not only because it implies the cause of the housing finance crisis was a lack of borrower commitment, rather than bad products or a failure to underwrite properly, but also because the tightening of down payment requirements has a direct effect on access to homeownership. It is therefore an issue of economic justice, and new research suggests higher down payment requirements may be as unnecessary as they are unjust.
For low- and moderate-income (LMI) Americans, owning a home might be the main, or only, opportunity to build wealth, finance education, promote retirement security, and pass an inheritance on to children. Traditionally, for LMI households the down payment has acted as an obstacle to this means of wealth creation. While LMI households might be able to afford mortgage repayment and home maintenance, they are prevented from doing so by the costly entry into homeownership.
As down payment requirements increase, access to homeownership will be determined by who has funds required for higher down payments. As Brandeis Professor Tom Shapiro explains, “because whites are far more able to give inheritances or family assistance for down payments white families buy homes and start acquiring equity an average of eight years earlier than black families.” Shapiro is concerned that the difference in access to homeownership helps increase the black-white wealth gap that has been well documented in our country. Our research at the UNC Center for Community Capital provides evidence to support this theory.
For the past 11 years, the UNC Center for Community Capital has been conducting a panel evaluation of a group of LMI homeowners who obtained their mortgages through programs designed to help banks earn credit under the 1977 Community Reinvestment Act. These loans, collectively known as the Community Advantage Program (CAP), were structured for both affordability and sustainability: they are 30-year, fixed-rate, purchase-money loans, and the majority of them had down payments of 3 percent or less. The loans went to borrowers who would have been unlikely to receive finance in the private mortgage market.
Our analysis of the CAP portfolio undermines the argument for increasing down payment requirements. Most strikingly, we found no significant differences between the performance of loans that included or didn۪t include assistance: within this portfolio of LMI borrowers, there is no evidence that mortgage performance improves or declines for those who use assistance compared to those who do not.
Despite borrowers۪ low down payments and low income levels, the loans in the CAP portfolio have performed very well: in the 4th quarter of 2009 the height of the mortgage delinquency crisis the CAP loans had a serious delinquency rate of 9.6 percent, which was lower than that for subprime fixed-rate loans (22.1 percent), subprime adjustable-rate loans (47.7 percent), and even adjustable-rate loans for borrowers with prime credit ratings (18.1 percent).
Our research also suggests that there is a real concern about the equity and fairness of increasing down payment requirements. While 38 percent of the owners in this study used some form of assistance beyond their own savings and assets to get into their homes, sources of assistance varied by race: black borrowers were 14 percentage points less likely than whites to receive help from their parents but were 10 percentage points more likely to use assistance in the form of a community grant.
If down payment requirements are increased, whites will tend to rely on additional funds from family members, while blacks will be more dependent on sources of assistance that are affected by public policy and political will.
The CAP portfolio demonstrates that lending to LMI borrowers can be successful, provided the loans are carefully underwritten and structured for affordability. Down payments can be small, and borrowers can succeed even if they do not contribute the entire down payment themselves. Should legislators and policymakers choose to increase down payment requirements despite evidence that this is not needed, then they must also increase their support for community programs to help all qualified borrowers make their down payments.
Allison Freeman is a senior research associate at the UNC Center for Community Capital.
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