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JCHS: Why We Should Care About the Great Recession’s Most Unfortunate Victim: Homeownership

Why We Should Care About the Great Recession’s Most Unfortunate Victim: Homeownership

 by Rob Couch
Guest Blogger
From time to time, Housing Perspectives features posts by guest bloggers. This post was written by Rob Couch, a member of the Banking and Financial Services, Real Estate and Governmental Affairs practice groups at the law firm Bradley Arant Boult Cummings in Birmingham, Alabama.  Rob also serves on the Housing Commission of the Bipartisan Policy Center in Washington, DC..  Previously, he served as General Counsel of the U.S. Department of Housing and Urban Development and as President of the Government National Mortgage Association (Ginnie Mae). His post reflects thoughts he shared at a Brown Bag Lecture delivered at the Harvard Kennedy School on November 14, 2013.In my lunchtime talk at the Harvard Kennedy School, sponsored by the Joint Center for Housing Studies, I discussed why recent government efforts enacted in the wake of the financial meltdown have caused increasingly stringent underwriting standards. These efforts have resulted in fewer homeowners, particularly first time purchasers, and the widening of the homeownership gap between certain minorities and white Americans. One of the questions from the audience during my talk came from a young man who challenged the continuing validity of the “Dream of Homeownership.”

After the bubble of 2007, some might think homeownership isn’t as worthy a goal as it used to be. In particular, younger Americans who have recently witnessed homeowners suffer financial loss or foreclosure due to declining home values or job loss may be especially wary.  A sizable percentage of young people are not yet in a stable career and want the flexibility that renting offers, and many young Americans who do want to own a home cannot meet underwriting criteria or afford a down payment given the combination of student loan debt and high unemployment.

Nonetheless, as Eric Belsky explains in his paper, The Dream Lives On: The Future of Homeownership in America, most young adults surveyed say they intend to buy a home in the future.   Furthermore, the results of several surveys cited in Belsky’s paper reveal that a majority of both owners and renters believe that owning makes more sense than renting. And for good reason; numerous studies have confirmed the economic and societal benefits of owning a home.

As a homeowner makes payments against his mortgage, and as the value of the property appreciates, the borrower’s equity in the home increases. If necessary, this equity can be accessed though the sale of the home or through a “cash out” refinance or a revolving line of credit. Homeowners also enjoy tax benefits as, in most cases, the annual interest paid on a mortgage and property taxes are fully deductible. Due to the long-term fixed-rate feature of most mortgages and the lifetime cap placed on adjustable-rate mortgages, homeowners are insulated from some of the inflationary pressures on the cost of housing faced by renters.

For the past thirty years, the wealth gap between the most affluent citizens and moderate wealth families in the United States has steadily widened. Households that are able to convert their greatest monthly living expense – rent—into a tax protected asset through amortizing long-term debt have a powerful tool for accumulating wealth. The family that owned its own home in 2010 had a median net worth of $174,500, compared to families who rented and had a net worth of $5,100. Belsky’s paper provides a more detailed analysis of the financial benefits of homeownership.

The benefits of homeownership extend beyond the financial ones, though. Children who grow up in owned homes have higher academic achievement scores in both reading and math and have a25% higher high school graduation rate than children whose parents rent. Children of homeowners are twice as likely to acquire some post-secondary education, and they are 116% more likely to graduate college. As adults, they earn more and are 59% more likely to own their own home, extending the benefits of homeownership on to the next generation.

Society as a whole also benefits from homeownership. Research has shown that homeowners are more likely to be satisfied with their neighborhoods, and thus more likely to give back to their communities. People who own their homes more often participate in civic activities and work to improve the local community, and they are 15% more likely to vote. Lastly, they tend to have greater longevity in a residence, leading to a more stable neighborhood.

Considering the benefits homeownership offers to society as a whole, young Americans aren’t the only demographic group affected by recent policies. Recent reports estimate that the African-American community, with wealth more concentrated in homeownership than any other asset, lost more than 50% of its net worth during the housing crisis. The deterioration in homeownership has been disproportionately severe on African-Americans, Hispanics, and younger people, leading to a widening of the gap in minority/white homeownership rates.

Recent government efforts to protect borrowers who fail to pay their loans, particularly settlements that have been extracted from the industry and increased servicing standards, have had the effect of compounding the losses from bad loans, thereby encouraging even more conservative lending and hurting a much larger group of potential borrowers by depriving them of the opportunity to achieve homeownership. The overarching policy goal should be to facilitate homeownership, not to shift the burden of non-performance from defaulters to aspiring borrowers. Policies need to change if we wish to continue making homeownership a reality for the broadest group of eligible borrowers in the United States.  My recent paper, The Great Recession’s Most Unfortunate Victim: Homeownership, discusses how we can address this important issue.

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Why a sizeable downpayment is so important for the long-term health of the mortgage market?

Why a sizeable downpayment is so important for the long-term health of the mortgage market – Market data clearly shows that a low downpayment is directly related to higher mortgage delinquency rates. When loan-to-value exceeds 90 percent delinquency rates rise above 10 percent..

I’m a bit perplexed why so many people think that a low downpayment has very little to do with mortgage delinquencies.  Aside from the actual facts that show a low downpayment does correlate with significantly higher defaults rates, it also makes logical sense.  I believe part of this mentality stems first from not knowing the facts, but also believing that this shifts blame from the financial industry or government backed system we currently have for purchasing mortgages.  On this front I do agree that the financial industry is the prima causa of the financial crisis and there is plenty of blame to go around.  Yet if we are to reform the system we need to understand what can be done to fix the mortgage market moving forward.  A low downpayment is unhealthy for a variety of reasons as we will discuss below.  I’ll give a few reasons for why having a larger downpayment is absolutely crucial in bringing back a semblance of sanity into the mortgage markets but also from stifling potential future price bubbles.

FHA share of market


The first point I would like to make is that the share of FHA insured loans has reached an all-time high.  It isn’t because these loans are better priced from other conventional loans but because Americans are unable to come up with even a 10 percent downpayment that these loans now dominate the market.  You might ask why was it low in the 2000s then?  3.5 percent is all that is required for a loan that is insured through the FHA but during the 2000s you were able to get zero down mortgages or other exotic loans that were even easier to land (and more lucrative on the surface) than FHA loans.  As the exotic financing market imploded interest has now shifted to FHA insured loans because they are the next loan in the line of easy to get mortgages.

You need to remember that FHA insured loans were never meant to be a big part of the mortgage market and their core mission was to help with affordable housing.  Nationwide in 2010 FHA insured loans made up close to 20 percent of all purchase activity (a big leap from 3.7 percent in 2006).  What is fascinating is the reality that these loans now makeup a large portion of activity in bubble markets that by definition are not affordable to begin with.  Take for example the most expensive county in Southern California, Orange County:

fha share of oc market

Source:  Everything Housing

So FHA insured loans are now a large part of the financing for one of the most expensive counties in the United States.  In Southern California overall it is worse.  33 percent of all home purchases last month were made with FHA insured loans.  The median down payment?  You guessed it, 3.5 percent.  Given our weak economy and the reality that FHA loans carry PMI and higher interest rates, the underlying answer why people are choosing this loan product is because they are unable to save enough for a downpayment to purchase a bubble priced home.  Ironically the FHA which is touted as helping those to find affordable housing is actually keeping prices inflated in many markets.

The data is rather clear but let us move onto the facts showing that low downpayments actually carry a much higher default rate.

Data on mortgage delinquencies by downpayment

delinquency qualified loans

Source:  Felix Salmon

Felix Salmon did a fantastic post poking holes through the downpayment argument.  The mortgage industry makes money by churning loans and sucking out commissions.  The lower the downpaymet, the more buyers you have in your pool.  This is not good although it may seem noble on the surface.  I’ve been trying to find reliable data on the entire mortgage market delinquency rates but it has been a challenge and Felix ran into similar road blocks.  We were able to look at option ARMs, subprime, and Alt-A loans for example but merely in silos and deduce that these loans were bad.  Of course this left a loophole open for the mortgage industry to argue that it was the underwriting, not the downpayment that was an issue.  Well now we have some aggregate market data here proving what should be obvious.  A lower downpayment does have a higher delinquency rate.  Just look at the chart above:

“When the mortgage industry starts complaining about the 14 million people who would be denied the chance to buy a qualified mortgage if they don’t have a 5% downpayment, it’s worth remembering that qualified mortgages for people who don’t have a 5% downpayment have a delinquency rate of 16% over the course of the whole housing cycle.”

I’m horrified that there is even a battle to require a 5 percent downpayment.  Ultimately the industry isn’t concerned with long-term solvency but for quick commission churns and actually keeping home prices inflated.  Once again the industry fails to look at stagnant household incomes and instead focuses on getting people into homes without requiring them to save or the long-term sustainability of the system.  After all, when things implode it will be the taxpayer that shoulders the cost for the banking industry and the defaulted homeowners.  The above chart is rather clear.  Once you move below the 10 percent downpayment mark you start seeing delinquency rates of 10 percent or higher.  This is enormous.

“And you can see too why the 20% downpayment limit was put in place: it’s the point at which delinquencies fall to less than 5%. If you take one group of loans with a 20-25% downpayment, and a second group of loans with a 15-20% downpayment, then the second group, on these numbers will have a delinquency rate 56% higher than the first.”

I’m not sure what more evidence is needed to show that a low downpayment mortgage does increase the chances of delinquency dramatically.  It would make logical sense that the less you put into a place, the less vested you would be in it when times became rough or the fact that you simply did not have the economic means to save enough for a buffer.

Strategic defaults

There is also data showing that people that strategically default on a loan actually have higher credit scores.  On the surface you might think this does not make sense but it actually does.  First, those who strategically default actually have the money to pay their mortgage.  That is, they are not like the majority of people losing their homes who flat out don’t have the cash flow to keep up with their mortgage payment.  These are people who consciously choose to stop paying their mortgage.

There is a large number of people living in homes with no mortgage payment for over 2 years:
loans in foreclosure

This is frankly a jaw dropping figure.  Yet this makes sense with so many people in the last decade buying homes with virtually nothing down with exotic loans.  People in effect used mortgages as large call options.  If home prices soared, these people were able to use other people’s money (OPM) to leverage up to the stratosphere.  Yet if prices collapsed as they did, the only thing they were out was the paltry down payment (which in many cases during the bubble was zero).  Easier to strategically default when you put down zero or 3.5 percent instead of 20 percent.

Demonstrate you can save for a rainy day

The reason why a downpayment helps keep delinquency rates lower and the data shows this is that it actually demonstrates an ability for a household to save before buying.  There is no reason why someone should be given a large mortgage simply because they want “homeownership.”  This is the nonsense we got from the last few leaders in D.C. and the only people that ended ahead in the last decades are the big financial banks on Wall Street who finance the D.C. leadership.  Homeownership rates have erased all the gains of the last decade and household wealth has gone through a lost decade.  Not everyone can own a home without going into financial peril.  It is also the case that by allowing anyone with a pulse to buy you artificially inflate prices on the front-end but society ends up paying in the long-term because as we are now seeing, defaults will occur and the cost is reflected through bailouts.

Another argument I hear is “well if someone were to save for a California home, it would take over a decade to save 20 percent!”  Well isn’t that the point?  How in the heck did people do it before the housing bubble?  The reason it has become so hard to save 20 percent is because many areas are still in freaking bubbles!  Nationwide the median home price is roughly $158,000.  Let us be conservative and say that all mortgages backed by the government would require a 10 percent downpayment.  So we are talking about $15,800.  Ironically this is close to the 3.5 percent down needed for an FHA insured loan of $500,000 ($17,500) which is being used extensively on bubble priced California homes.

The case is rather clear that moving forward, a larger downpayment is one component of improving the mortgage markets for future generations.  But then again, investment banks and D.C. are primarily concerned with churning out volume in the short-term even if it comes at the expense of future generations.

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