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Pendulum swinging back to reasonable down payments on homes

WASHINGTON — Partisan politics aside, presumptive Republican nominee John McCain proposed something March 25 that no other major presidential candidate has advocated in decades: raising minimum down-payment levels for home mortgages.

No more zero-down deals. No more "piggyback" plans that combine 90 percent first loans with 10 percent seconds. No more "down payment assistance" schemes where sellers indirectly supply all or most of the cash needed for the buyer's down payment.

Even the 3 percent minimum required by the Federal Housing Administration would be raised under McCain's plan. That puts him squarely at odds with the Bush administration and Democratic leaders in the House and Senate who are currently negotiating reform legislation that would cut FHA's minimum to zero, favored by the House, or 1.5 percent, favored by the Senate.

Proponents of low FHA down payments say they are necessary to allow moderate-income families to purchase first homes, and that if properly underwritten and serviced, they do not lead to extraordinarily high default or foreclosure rates.

'Skin in the game'

McCain also said the giants of the mortgage industry — congressionally chartered Fannie Mae and Freddie Mac — "should never insure loans when the homeowner clearly does not have skin in the game." He did not specify how much skin would be needed.

McCain thinks a key contributing factor to the current national mortgage crisis was the tiny or nonexistent equity contributions required by lenders during the boom years. When the boom fizzled and home values fell, many borrowers found themselves in negative equity positions, owing more on their mortgages than the market value of their homes.

Though neither of his potential Democratic opponents nor the White House has commented on the McCain proposal, efforts to rein in down-payment minimums already are under way by major private mortgage lenders and insurers. Fannie Mae and Freddie Mac both have raised fees on new loans where borrowers have less than 25 percent equity. They also have increased minimum credit scores for low-equity mortgages.

Credit is tighter

Private mortgage insurers have tightened availability of new loans with less than 5 percent down by raising credit standards for applicants, and refusing to underwrite such loans in markets they designate as declining.

The emerging trend in the private marketplace reverses one of the hallmark practices of the boom years. When the National Association of Realtors surveyed thousands of first-time buyers in late 2004 and early 2005, it found that 43 percent had put no money into their purchases. The same study documented the median down payment by first-time purchasers at just 2 percent, which dropped to 1 percent in high-cost areas such as California where zero-down piggyback plans were wildly popular.

The net result, as the real estate market began turning in mid 2005, was that large numbers of people started their homeownership experiences underwater. Research by a subsidiary of First American Corp. found that by 2006, one out of 10 households that took out loans the prior year were already at a zero or negative equity position. Another 5 percent were negative by 10 percent or more, with mortgage debt balances at least 10 percent higher than the market value of their properties.

The same study found that one out of three purchasers nationwide had an equity cushion under 20 percent. Forty-four percent had less than 30 percent equity. Areas where owners had the least equity — California, Colorado, Florida and Ohio — subsequently have seen some of the highest foreclosure and delinquency rates.

What's the national situation on equity holdings among all American homeowners, including people who took out their mortgages long before the boom? The Federal Reserve Board researches that question periodically through its "flow of funds" studies. Here's what it found most recently:

From the fourth quarter of 2006 through the fourth quarter of 2007, homeowners lost $387.5-billion in net equity holdings, mainly because of property devaluations in major markets across the country. The year-end $9.65-trillion in equity was the lowest since mid 2004.

Back to upfront equity

At the end of 2007, according to the Fed, American homeowners' equity was 47.9 percent, down a full percentage point from the third quarter, and 6 percentage points below 2003. Any way you look at it, $9.65-trillion is a vast financial resource, and a national loan-to-value ratio around 50 percent means most homeowning households still have hefty cushions.

But don't look for the return of mass-marketed zero-down mortgages any time soon. The private marketplace is heading back to more traditional standards, where equity upfront was the rule.

E-mail Kenneth R. Harney at

Pendulum swinging back to reasonable down payments on homes 04/04/08 [Last modified: Saturday, April 5, 2008 6:27am]
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