Readily available mortgage credit disappeared during the most recent housing crisis. Between the Dodd-Frank regulations and the penalties leveled against banks for substandard loans, the incentive for banks to lower credit standards did not just evaporate; it reversed.
Banks are currently keeping their lending criteria well above the minimum levels for Fannie Mae and Freddie Mac to be able to purchase the loans. The Federal Housing Finance Agency (FHFA) reported a current average borrower FICO score of 743, considerably above historical averages and far above the 620 score that marks the beginning of the subprime scale. Many banks consider 660-680 the lower range for approving loans.
Predictably, the housing market is being slowly strangled through overly tight credit. Equally predictably, the government is trying to bring more marginally qualified borrowers back into the housing market.
One of the methods being used is restoration of higher loan-to-value (LTV) ratio loan options – in particular, the 3% down-payment mortgage loan. Fannie Mae stopped accepting loans with less than 5% down payment in 2013, but Fannie Mae’s CEO announced in October that they would again accept loans with 3% down under certain circumstances. Those circumstances are yet to be worked out, but they will offer an alternative to the current 3.5% down FHA-loans that come with greater restrictions.
Meanwhile, lenders are waiting for the details to emerge. The return of the 3% down mortgage loan has been rumored for some time as a byproduct of recent talks between lenders and FHFA/Fannie Mae representatives.
In return for the lowered down payment limits, lenders are expecting clarification on required repurchasing of bad loans. The intent is to make sure buyback is only mandated for loans that truly deserve to be returned, separating loans with simple clerical errors from those that are fundamentally fiscally unsound.
Banks look at the FHFA efforts as Lucy holding a football, trying to tempt banks to give the football a swift kick. However, banks are harder to fool than Charlie Brown. Fannie Mae may offer to buy the loans, but they cannot force the banks to make them.
If the FHFA and banks reach a proper compromise, this is good news for all. Banks can free up the excess of cash that they have been sitting on, and will make more money through more mortgage customers and longer periods of private mortgage insurance (PMI) per loan (assuming limited defaults). Marginally qualified buyers will be able to purchase homes. The housing market will improve as a result, meeting the government’s expectations.
There are some banks that are offering 3% down loans and keeping the loans themselves – TD Bank did so back in April – but those come with higher interest rates and other potential restrictions. The hope is that lenders will offer 3% down payment mortgages with low enough interest rates and fewer restrictions than the existing options.
What does this mean for you if you are in the market for a home? You should have more options to purchase a home with a lower down payment – but you do not have them yet. Keep an eye on the FHFA guidelines once they are announced, and look for feedback from the banks.
Finally, remember one other thing – just because a 3% down payment mortgage is more accessible does not mean that it is the best choice for you. Make sure you have correctly assessed your future ability to pay and the security of your income stream before going down the more risky path of a higher LTV mortgage.
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