Low-down-payment mortgages are back

One of the culprits in the building and bursting of the nation's housing bubble, the low-down-payment mortgage, is back in favor and readily available at a lender near you.

Numerous firms are taking part in a new and somewhat controversial program offered by Fannie Mae for fixed-rate conventional home loans with 3 percent down payments. Freddie Mac starts backing similar loans next month.

The two bailed-out housing finance corporations reintroduced their 3 percent down products in December as a way to assist prospective first-time home buyers who have the income to pay off a mortgage but lack the savings for a large upfront payment. Before the announcement, Fannie and Freddie's lowest down payment option was 5 percent.

Lenders say that millennial home buyers — those born after 1980 — can especially benefit from this new 3 percent down program.

Proponents contend that the 3 percent-down-mortgages are vastly different from the risky subprime mortgage products that fueled the housing bubble and led to the financial crisis. As a result of the crisis, the federal government infused Fannie and Freddie with $187 billion once borrowers started defaulting. (They've since repaid the bailout with a $38 billion profit.)

Adjustable rates or interest-only teaser periods are forbidden. Borrowers must accurately document their finances and ability to repay. And they also need a minimum 620 credit score, a low debt-to-income ratio and must take a homeownership course.

"There's many factors that go into the risk of a certain loan and down payment is just one of them," said Fannie Mae spokesman Andrew Wilson. "You get into the danger zone when you're layering a lot of risk factors."

That danger — real or exaggerated — was a hot topic among Republican members of the House Financial Services Committee during Jan. 27 testimony by Melvin Watt, director of the Federal Housing Finance Agency that regulates Fannie and Freddie.

Down payments of about 20 percent were the norm for most home mortgages before the 1980s. A large down payment helps assure lenders that a borrower has enough of a stake in the property to keep up with the monthly payments. Sizable down payments also make it less likely that borrowers will walk away if home values fall and they owe more on their mortgage than the property is worth.

Fannie and Freddie relaxed their down payment requirements during the 1990s, moving from 10 percent to 5 percent to 3 percent, and later even zero-percent down in the early 2000s.

The government's Financial Crisis Inquiry Report concluded that Fannie and Freddie "added helium to the housing balloon" by buying subprime mortgage-backed securities and loosening their standards for guaranteeing loans. But they weren't central causes of the crisis: "They followed rather than led Wall Street and other lenders in the rush for fool's gold."

After the crash, Fannie and Freddie were crucial to propping up the housing market when lenders were skittish to make loans without government guarantees. Together, both entities own or guarantee just under 60 percent of all new U.S. mortgages.

"We've gone from the extreme where if you can fog a mirror you can get a loan to where people who have very strong qualifications, but only for the ability to save up enough money to put down a larger down payment … are simply being excluded from ownership opportunities," said Paul Leonard, a senior vice president at the Center for Responsible Lending.

The center has argued that requiring down payments of 10 percent or higher will bar many middle-income families from owning homes and widen wealth disparities between whites and minorities.

"There are a lot of folks who are quick to suggest that any changes from today's historically tight credit standards will lead us down into the abyss," Leonard said. "But the reality is the world is a different place."