by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
I had some fun, yesterday, with a report about the down payment assistance ban and the First-Time Homebuyer Tax Credit. I poked fun at the hypocritical nature of the Down Payment Assistance Programs and speculated that the Tax Credit might be collateral for a “tax refund loan”, thereby, facilitating the need for down payment funds today.
The whole thing is silly when you think about it. 100% financing, through the FHA, is the answer. Then, we can stop winking at the violation of the spirit of the law. Some commenters, suggested that 100% financing, or attempts to provide down payment assistance, is dangerous and might bankrupt HUD. The fact is that down payment assistance programs have a default rate that is twice the normal acceptable FHA default rate. The universe of FHA loans have a default rate of 3-3.5% while DPA loans are 7-9%.
While it’s easy to say that over 9 out of 10 buyers, who use the DPA program to buy a home, succeed, the high default rate COULD bankrupt the FHA insurance fund. I queried some senior bank credit officers about this. What I discovered is that those defaults CAN be managed if we layer the risk. For you non-mortgage types, that means that we tighten one C if we loosen the other. I was astounded to hear that over half the DPA defaults could have been avoided if underwriters strictly adhered to a recommended debt-to-income ratio of 29/41 and a minimum credit score of 620.
Compliance to the underwriting guidelines then, could make DPA programs, or 100% financing work.
Last year, I wrote a letter to Senator Dodd, here on Bloodhound Blog. That letter introduced me to a few contacts inside the Beltway; I called them today . What I heard was classic political maneuvering. The recently passed Housing Law was a compromise. Republicans, siding with the HUD Commissioner, effectively banned the DPA programs and INCREASED the minimum down payment requirement, on FHA loans, to 3.5%. Democrats, capitulated on the eventual DPA ban because they prohibited HUD from engaging in “risk-based” pricing, which is, higher rates for people who might not make timely payments.
The delayed ban on DPA programs is allegedly the brainchild of Congressman Barney Frank. It is said that he believes that risk-based pricing COULD be abused but is holding it as a trump card to restore the DPAs. My call to his office went unanswered but I left a message inviting him to be interviewed on Bloodhound Blog. Should Congessman Frank accept, I’ll share it with you on a podcast.
The answer is, of course, layering the risk and charging for it (through higher upfront mortgage insurance premiums) for 100% FHA financing. If the default rate can be lowered to a manageable level, and the potential credit loss can be mitigated through higher MIP, we might just have a winner. Rather than focusing our efforts on the irresponsible (through the short refinance program), we could be encouraging responsible home ownership for new buyers. The expression “It’s easier to give birth than to raise the dead” comes to mind.
Easy money isn’t the problem; cheap, easy money is. 100% financing can make sense for the young cop, firefighter, or teacher, who wants to buy a bargain-priced home in their community….
…provided they have superior credit and a demonstrable ability to repay the loan.
Dylan Darling says:
Down payment assistance programs are needed in this housing crisis. The qualifications may need to go up, but we need DPAs. In our market, many first time buyers are looking at $250k-$300k for a home. Most can’t afford the 3.5% down plus closing costs, but do have the ability to make the monthly payment and repay the loan. We need to give these people an opportunity to buy a home, which cuts inventory and will help boost the housing market.
August 28, 2008 — 10:00 am
Bob says:
Excellent piece Brian, but I am surprised to hear you say
August 28, 2008 — 8:06 pm
Brian Brady says:
I thought they DID adhere to those guidelines, Bob. The lower default rate (when underwritten properly) kind of debunked the myth that no down payment loans won’t work. I NATURALLY thought they would tighten up two Cs when they loosened up one C (silly me)
August 28, 2008 — 8:15 pm
Bob says:
The last FHA loan a client of mine used around 2002 went thru with a 51% backend.
They didnt default, but I do agree that intelligent underwriting results in lower defaults.
August 28, 2008 — 8:38 pm
Michael Cook says:
Shouldnt down payment assistance have some kind of a price ceiling? Dylan mentioned firemen and teachers buying homes in the $250-300k range. At what point do we say thats too much. If you can afford to buy that home, you can afford to save for the down payment? Perhaps the problem would solve itself if there was a cap of 200k because in most neighborhoods that is a good starter home and its near the national average? And if you say, well that couldnt buy anything in Manhattan. I will agree and counter with, perhaps firemen and teachers should live in Brooklyn? Sure it sounds insensitive, but it makes financial sense.
It just seems outrageous to me to see someone getting downpayment assistance to buy a home that they can’t afford. The whole concept seems a bit out of wack to me.
August 29, 2008 — 5:28 am
Brian Brady says:
“I will agree and counter with, perhaps firemen and teachers should live in Brooklyn? Sure it sounds insensitive, but it makes financial sense.”
I’ll agree with that, Michael. Some cops and fireman, with working spouses, can afford a $400,000 home; in SoCal, that’s no palace
August 29, 2008 — 12:41 pm
Jason Stevens says:
I think that is what got us in this problem the first time. Just like anything, its not the program that’s bad, it’s abuse of the program! Down Payment Assistance is a wonderful program, but was abused. Just like No doc loans…another wonderful program, especially for self employed. However, when a 24 year old, who never messed up his credit, and has scores over 700, and is a manager of a restaurant, making $44,000 a yearl; and wants to qualify for a $380,000 home, solely based on his credit scores….he’s being doomed to failure unless he has some other source of income.
If they just regulate the use of Down Payment of Assistance, instead of eliminating it, everyone would be much better off!!
Jason Stevens
Own Your Own Home
http://www.oyohaz.com
August 29, 2008 — 1:06 pm