Will a 20% down payment plan help or hinder the US housing recovery?
The Future of the American housing market is still unclear 4 years after the subprime bubble burst.
From that we know that things that were tried so far have:
- Not worked,
- Had limited success, or
- Are not sustainable.
What would a 20% deposit minimum mean to home buyers?
One thing we all know is that getting a home loan will no longer be a walk in the park for borrowers or for mortgage brokers.
First home buyers will be the first to suffer. They will have to be motivated to save a deposit, before they qualify for a home loan.
That will have several implications.
- Less home buyers will mean lower demand and house prices.
- First home buyers will build smaller homes.
- Low income earners maybe precluded from homeownership.
- Mortgage brokers will leave the industry, looking for an easier way to make a living.
- Home buyers will be more reluctant to pursue a home loan, and save the deposit, and that means that homes will be a lot cheaper.
U.S. bank regulators decided to propose a high standard for home buyers to get the best mortgage rates:
- Only those who can make a 20 percent down payment and have not had problems paying mortgages in the recent past would be eligible for the lowest rates.
What about mortgage insurance?
Well what about mortgage insurance? Think about it.
The lender was saying "I don't want this loan unless you the borrower stumps up insurance to protect me, the bank from you defaulting."
Is that in the lenders or borrowers interest? Some would argue both, because it meant that you did not have to save much by way of deposit. But it had the effect of allowing more buyers to enter the market and that meant more demand and higher prices. These meant that new home buyers had to pay more and that's what a higher deposit will prevent.
It also meant that easy finance, meant more home buyers, and more buyers meant higher demand and higher prices.
So to see how this would play out.
let's suppose that only people with clear credit and big deposits get cheap loans.
One of the key new regulations would require mortgage lenders to invest in the loans they make, so that if the loans went bad, the lender would suffer.
In the years leading up to the financial crisis, lenders could hand off loans, many of which were known to be high-risk or never to be repaid, to other companies at a discount.
By selling the risk to others, they could then continue to make even more risky loans risky loans till the deal went toxic.
The twenty percent rule and a rate for risk scenario
But these rules would exempt banks from having to retain risk in loans made to borrowers who can offer a 20 percent deposit.
They also would exempt Government guaranteed loans, such as by federal-backed mortgage companies Fannie Mae and Freddie Mac.
What's wrong with the 20% deposit rule?
Home buyers’ advocates have criticized the 20 percent down payment rule.
Regulators had considered mandating a 10 percent down payment and this seems to have had broader support.
- Many feel that a 20% deposit, and clear credit rule combination maybe too steep an ask for people to save, especially first home buyers.
- Second home buyers can do this on the equity in the home, if there is any in the US housing market right now.
- The 20 percent requirement might preclude banks from making any loans that are not Government Guaranteed.
Summary
There up to eight different proposals in bills that are trying to resolve the US mortgage industry and revive the housing market.
One thing is for sure. It was a lot easier thing to trash the US finance markets than it is to find a solution.
But all solutions point to making credit harder to lend or borrow. That will have to mean that house prices will be lower for some time to come. In the end home buyers and eventually first home buyers will be better off. But homeownership will become harder to initiate in the years ahead, but an easier thing to continue. In the end, it will be worth it.
