The housing bubble was apparently too far in the past for many of the people writing about housing to remember. Part of the problem was that many borrowers got loans that they were ill-situated to repay.

One of the factors that is a strong determinant of whether people will be able to pay a mortgage is the size of the down payment. The equity from a down payment serves as a cushion in bad times. It also reduces the risk to lenders, since this is money they stand to recover in the event of a default.

The NYT misled readers about the relative risk from low down payment loans in an article on the decision by the government to allow Fannie Mae and Freddie Mac to purchase loans with just 3 percent down payments. The piece cited several commentators saying that the risk of defaults would not increase substantially by lowering down payment requirements.

A study by the Center for Responsible Lending found that the default rate for loans with down payments of between 3 to 10 percent was 6.8 percent. This is 45 percent higher than the default rate it found for mortgages with down payments of 10 percent or more. The gap would be even larger of the comparison was restricted to those with down payments between 3 to 5 percent, with mortgages with down payments of 20 percent or more.

It is dubious housing policy to encourage moderate income people to take out mortgages on which they are likely to default. Furthermore, since the median period of homeownership among low income homebuyers is less than five years, a relatively small portion of households who are able to buy homes through this policy will accumulate any substantial amount of wealth. By contrast, the policy is likely to help the banking and real estate industries accumulate wealth.



In response to the questions in the comments, the study did not directly give the 57 percent figure, you had to back it out from the numbers they did give. According to their data, the additional low down payment mortgages raised the overall average from 4.7 percent to 5.2 percent. In order for this to be the case, the default rate on the additional mortgages had to be 6.8 percent -- in other words, 45 percent higher than the higher down payment mortgages.

In fact, assuming their analysis is like every other analysis of default rates, it found a strong inverse relationship between the size of the down payment and the default risk. The likelihood of defaults for those putting down 3-5 percent is probably close to four times as high as those putting down 20 percent. I think it's great to help low and moderate income people get good housing. But this policy is about helping banks get their bad mortgages insured by taxpayers.

One more point, it is a lie to say that this is an issue about people being able to get a mortgage with a low down payment. This is an issue about people being able to get a government guaranteed mortgage with a low down payment. We are talking about people paying a higher interest rate that reflects the actual risk associated with their mortgage.


Correction: An earlier version had put the difference at almost 80 percent due to an arithmetic error. Thanks to Bill Sermons, at the Center for Responsible Lending for calling the error to my attention.