Remember Mortgage Crisis: Lowering Down Payments Might Not Be the Answer

Mike Ginsberg

The mortgage market is over $8 trillion, and nearly 70 percent of all consumer debt, so changes in the mortgage market have a huge impact on all other areas of consumer debt. In addition to mortgage being a small sector in the debt collection world, the massive market supports credit grantors, ARM service providers, and many other industries.

On October 20^th, shortly after the release of our last mortgage blog (click here), FHFA Director Mel Watt announced that mortgage-finance companies Fannie Mae and Freddie Mac would start backing loans with down payments as low as 3% (click here). This announcement has received mixed reviews to say the least.

There is the potential for this policy to boost to the economy under the belief, “if you build it, they will come.” The premise of the benefits derived from this policy is that it expands the pool of potential home owners. Right now, housing is going up at an alarming rate as detailed in the following chart, so increased demand is essential to the housing market.

To date, demand has not been what policy makers would have hoped. For creditors, the increase in the pool of potential buyers implies increased lending and more interest revenue. For ARM service providers focused on this market segment, this should result in increases in placements for past due accounts. Everyone would love to see housing fully recover and stimulate the economy the way it did in the early 2000’s. However, if you look deeper, a policy like this could go terribly wrong.

By expanding the pool of potential home owners through lower lending standards, the FHFA also reduces the quality of potential home owners. Further, by lowering the down payment standard, creditors have even less incentive to make a loan, especially with low interest rates. Consider a $200,000 mortgage, what used to be a $10,000 down payment (5%) is now a $6,000 down payment (3%). With creditors receiving less money up front for presumably riskier debtors, the debtors have less “skin in the game” and the incentive for lending goes down drastically. For ARM providers, decreased lending standards imply increased challenges in the billing and collection process.

Does this story sound eerily familiar to anyone? Interest rates were low, new home construction was high, and home purchases were booming. The year was 2006 and 2007 looked so bright…right before the onset of the Great Recession.

The low interest rates and relaxed lending standards – subprime lending – gave people with poor financial records the ability to own a home, but only so long as prices kept rising and equity could took care of the rest. At the time, this seemed like a really great idea that was a “win-win” for everyone. Unfortunately, nobody accounted for the negative effects associated with providing loans to low-wealth borrowers that had alright, but not great credit. This begs the question; do you think the FHFA thought about it this time?

Creditors and ARM servicer’s need to pay attention to these dangerous policies of low interest rate and borrowing standards that jeopardize the economic recovery and stability of the U.S. credit economy. While the idea that everyone should own a home sounds really great, it just isn’t realistic. This very idea brought on the mortgage crisis that started the Great Recession. Those that work with the FHFA, directly or indirectly, need to evaluate the trade-off of handling high volume-high risk accounts.