"Qualified Residential Mortgages" -- the Negative Impact of a Government-Mandated 10 Percent Down Payment
Published: August 29, 2012
Federal regulators are currently debating how to define “Qualified Residential Mortgages” (QRMs), a category of home loans established by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Under Dodd-Frank, mortgage lenders that sell their loans into the private secondary market must retain a portion of the loan’s risk unless the loan is designated as a QRM. Because lenders are strongly motivated to avoid future costs on loans they originate, the QRM standard will have enormous implications for the cost and availability of mortgages. Loans that fall outside the QRM parameters (i.e., “non-QRM loans”) will likely be significantly more expensive than QRM loans. Estimates of the spread range from 80 to 400 basis points, depending in part on what happens with other parts of the risk retention rule. It is imperative that federal regulators create a QRM standard that balances the need to rein in dangerous loan features with fair access to safe, affordable loans for creditworthy borrowers.
Loans with risky product features such as high fees, balloon payments, low teaser rates, or interest-only or negative amortization schedules will automatically be ineligible for QRM status, as will loans that do not verify borrower income (so-called “no-doc” or “low-doc” loans). The Center for Responsible Lending (CRL) supports these restrictions.
However, regulators are also considering imposing minimum down payment requirements as part of the QRM standard. While much has been written on the barriers to homeownership that would result from the 20 percent down payment requirement included in regulators’ April 2011 proposed rule, there has been less commentary on a possible 10 percent down payment.
The costs of imposing a mandatory 10 percent down payment are unacceptably high. Not only would such a requirement exclude creditworthy families from homeownership, but it also would undermine the nation’s economic recovery by further depressing the housing market. Consider these facts:
Low down payment loans are not the same as subprime loans and have been successfully used to help families become homeowners for decades. The current housing crisis was the result of abusive loan terms and practices in the subprime and Alt-A mortgage markets, not low down payment loans. Low down payments, when paired with responsible underwriting and safe loan terms, have proven to be a successful strategy for expanding sustainable homeownership for decades.
Arbitrary minimum down payment requirements would lock middle-income families out of the mainstream market and widen the wealth disparities that already exist between whites and communities of color. Given median housing prices and incomes, it would take over 20 years for the average family to save a 10 percent down payment plus closing costs. The barriers would be even greater for typical African-American and Latino families, for whom it would take 31 and 26 years, respectively, to save enough to meet such a requirement. Again, lending history has shown that many families who don’t have the funds for a significant down payment can become successful homeowners.
The high costs of a 10 percent down payment requirement far outweigh sparse marginal benefits. Imposing a mandatory minimum down payment requirement would produce a small reduction in default rates, but the marginal benefit would be dwarfed by the cost of denying millions of families the opportunity to become successful homeowners with mainstream mortgages. to prevent the types of lending that caused the current crisis. As a result, the marginal benefit of reducing defaults through a down payment requirement must be balanced against the cost of restricting access to affordable mortgages. A recent study by the University of North Carolina’s Center for Community Capital and CRL suggests that the trade-off is not worthwhile.
Looking at large sample of mortgages originated between 2000 and 2008, the UNC/CRL study shows that, after applying Dodd-Frank’s other mortgage protections, a 10 percent down payment requirement would have had a relatively small benefit in reducing defaults. Specifically, while a 10% down payment requirement would have reduced the default rate from 5.8 percent to 4.7 percent, it also would have locked 30 percent of all borrowers out of the market and would have excluded 9 borrowers who are currently successfully paying their mortgage for every foreclosure it would have prevented. In contrast, the study shows that a three percent down payment requirement reduces the default rate to 5.2 percent while excluding eight percent of borrowers (and would have excluded 6 successful borrowers for every one prevented foreclosure). Furthermore, the impact of a 10 percent down payment standard would be particularly acute for communities of color, as 60 percent of African-American and 50 percent of Latino borrowers who are currently successfully paying their mortgages would have been excluded from the mainstream mortgage market had such a requirement been in place.
The benefit of down payments in reducing individual borrowers’ default rates could be counteracted by the toll it would take on the larger housing market and economy. Including a down payment requirement in the QRM standard would depress housing demand, threatening the future recovery of the nation’s housing market and overall economy. By excluding so many families from accessing affordable mortgages, a high down payment requirement would likely depress home prices, decreasing the home equity of families across the country, and act as a drag on economic growth and employment. In doing so, it could actually undermine its primary objective of reducing individual default rates.
While CRL agrees that borrowers should have “skin in the game” when purchasing a home, how much borrowers need to invest in order to feel adequately committed varies by their financial condition: a three percent down payment for a lower-income family may be just as effective a personal investment as 20 percent for a wealthier family. And, while we recognize that down payments affect defaults, we believe that down payment thresholds should be set and priced by the market, not by the government.
Read more about our objections to a 10 percent down payment requirement as part of the QRM standard in the complete brief.