Hefty down payments not the answer to fixing mortgage mess

Michelle Singletary
Columnist January 24, 2012

During a recent financial workshop I conducted at my church, I met a single mother who couldn’t afford her mortgage.

She and I talked about her options, which included selling her two-bedroom townhouse and moving into an affordable apartment or getting a roommate. But while speaking with her, I had to suppress my anger.

Michelle Singletary writes the nationally syndicated personal finance column, “The Color of Money.” View Archive

I was angry with the lender that approved her interest-only loan. It’s true that the young woman should have realized that once her mortgage was adjusted to include principal, her monthly payment would crush her budget. It now takes more than half her monthly income to pay the mortgage, which leaves little room for her to save or cover her other expenses.

But having worked with so many homeowners in her predicament, I understand that the desire to have a home overrode the financial sense she needed to realize that in the long term, the mortgage would be too much to handle. She was trying to better herself by buying a home. She had the right intentions, so I have compassion for her and her situation.

However, the lender deserves disdain. All the folks involved in selling and approving her loan should have known she wasn’t ready to be a homeowner. Traditional and more prudent underwriting standards would have shown that she could not handle that mortgage.

It is this young woman I think about as I look at the regulatory efforts to deal with the fallout from the housing crisis. One proposal under consideration is to implement loan underwriting standards to ensure that borrowers have a reasonable ability to repay their loans long term and not just during a teaser-rate period.

Another idea would require borrowers to come up with a 20 percent down payment. If they don’t meet this threshold, their loans would be considered more risky and would not meet the definition of a “qualified residential mortgage,” or QRM. People could still get loans but if they didn’t have the 20 percent down, the bank would charge a higher interest rate.

Last spring there was much uproar from consumer advocates and the housing industry about the impact that higher down payments — 20 percent or even 10 percent — would have on future homeowners. A new study released this month by the UNC Center for Community Capital and the Center for Responsible Lending shows such a rule could push creditworthy borrowers into higher-cost loans, and perhaps out of the housing market.

Researchers looked at 20 million mortgages originated from 2000 to 2008 and examined whether different proposed guidelines, including a 20 percent down payment, might have affected loan performance and access to mortgage credit, looking at the entire market and at the impact on historically underserved households. Researchers concluded that had the tougher down payment standard been applied, 60 percent of the borrowers would not have qualified for the best interest rates.

Research shows that down payments help reduce the chance of a foreclosure because borrowers have more to lose. But that’s just one predictor. The new report also concluded that lenders can still make safe loans to borrowers who put less upfront if regulators restrict loans with features associated with higher default rates, such as the interest-only loan made to the single mother in my workshop or loans that lack adequate income documentation, or loans that allow “negative amortization,” which means that the unpaid interest is added to the mortgage balance. With negative amortization, you end up owing more on your mortgage than you originally borrowed.

“Clearly, the policy goal should be to encourage the origination of loans that are appropriately underwritten and that take into account a borrower’s ability to pay,” researchers said in the report.

The truth is, we do have to look at what regulations will help prevent another crash in the housing market. Between 2007 and 2010, 4.3 million homeowners lost their homes to distress sales including foreclosure sales, according to Moody’s Analytics.

There is no question we have to eliminate the industry practices that allowed lenders to make risky loans. No one is suggesting people shouldn’t put something down when they buy a home, but the percentage should be flexible.

“If a large share of borrowers are excluded from the mortgage market, either because the loans aren’t available or because they are priced too high, this could result in a lower demand for houses, which in turn could reduce house prices further and lead to higher foreclosures,” the report said.

With better and non-predatory guidelines, lenders can make good loans by looking at people’s income, major expenses and debt-to-income ratios. Changes have to be made, but we shouldn’t block homeownership from creditworthy people and their ability to lift their family economically because they don’t have a hefty down payment.

Readers can write to Michelle Singletary at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071. Her e-mail address is singletarym@washpost.com. Questions are welcomed, but because of the volume of mail, personal responses may not be possible.

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