During the housing boom, the mortgage mantra seemed to be “No income, no credit, no problem!” Today however, in the interest of reducing risk, there is a push for tougher requirements and a 20% down payment requirement. As one might imagine, the housing industry is not embracing the pendulum swinging back so far: [Thanks M.R.!]
Among the most hotly contested ideas bank regulators have proposed to reduce the risk of another financial crisis is rule making a 20 percent down payment mandatory on some new home loans. Consumer advocates, civil rights groups and lending industry groups alike have said the proposed rule would deter many families from ever buying a home.
A new survey by the National Foundation for Credit Counseling could shed light on the actual effects of the proposal: The survey found that half of the 1,000 people contacted thought they would never be able to put together a 20 percent down payment to buy a home.
Just how big a barrier would a 20% down payment be? According to Ken Edwards of the Policy Counsel at the Center for Responsible Lending,
Consider the enormous challenge for the average family to save enough money for even a 10% down payment:
For the average US household, it would take over 10 years to save enough for a 10% down payment and 2% closing costs, even if they saved for nothing other than a house.
For the average Latino family, it would take 12 years.
And for the average African-American family, it would take about 15 years.
These households include many families who are employed and have good credit records. Yet, a down payment would pose an unnecessary barrier to homeownership. Among renters, only the wealthiest 25% of white families nationwide have more than $5,000 in cash savings. For renters of color, only the wealthiest 25% have more than $2,000. Many families—white, brown and black—haven’t been able to put a lot of money away, but they can pay their mortgage on time every month.
As long as there is a huge overhang of housing inventory, there will be no recovery. While I am no fan of the easy lending of the past, I also believe that when lending becomes overly restrictive, regulators may find that their policies actually backfire. How is this possible?
When lending becomes overly restrictive, it reduces the supply of potential buyers. Fewer buyers means a greater disparity in supply and demand, putting downward pressure on prices. As prices fall, more borrowers are underwater and defaults increase.
The solution is to find a balance, where potential buyers have skin in the game, but don’t have to wait 10 years to save up that down payment. Even now potential buyers with good credit, good income and a down payment are being turned down for mortgages.
Higher down payments aren’t the only way to reduce risk. Another thing to consider is reduce the amount a borrower qualifies for. Lower prices mean lower risk and reduced risk of default.
Lending standards should be firm, but they need to be reasonable. Lending requirements that are too stringent may exacerbate the problems they were meant to rectify.