Bank of America (NYSE:BAC) CEO Brian Moynihan recently said that one regulatory change he'd like to see would be the reduction of the standard down payment on a mortgage from 20% to 10%. If this happened, Moynihan believes that more buyers would be able to obtain affordable mortgages, and banks would benefit from the added business, a win-win.
What Moynihan said about the down payment requirement
The majority of U.S. mortgages are underwritten to strict standards set by government-sponsored enterprises Fannie Mae and Freddie Mac. And one long-standing provision of these standards is a down payment requirement of 20%.
When speaking about potential regulatory reforms, Moynihan said, "Our goal – going back to regulatory reform – is should you move the down payment requirement from 20 percent to 10?" He went on to say that doing so could have a big, positive impact on the U.S. mortgage industry. "It wouldn't introduce that much risk, but would actually help a lot of mortgages get done."
Wait, aren't there low down payment options already?
To be perfectly clear, it's already quite possible to obtain a conventional mortgage without putting 20% down. In fact, Fannie Mae and Freddie Mac both have programs designed to approve borrowers with down payments of as little as 3%.
However, any down payment below the current standard of 20% on a conventional mortgage adds the additional expense of private mortgage insurance (PMI). While this would conceivably still apply to loans with less than 10% down, if the standard down payment were lowered to 10%, it would make it easier for potential borrowers to avoid PMI without having to save up nearly as much cash.
Here's an example of how much of a difference this can make in terms of home affordability:
Let's say that you want to buy a house for $300,000, but don't have $60,000 sitting in your savings account for a 20% down payment. However, you can reasonably come up with $30,000, so you apply for a 30-year conventional mortgage anyway.
Based on a 4% interest rate, this would produce a monthly payment of $1,289 (principal and interest). In addition, because you put less than 20% down, you'll also pay $133 per month for PMI, based on the current national averages. In other words, the result of the lower down payment is an increase of more than 10% on your monthly mortgage payment.
An additional $133 may not sound like too much, but since it must be paid until the loan-to-value falls below 80%, this means that over the course of your mortgage, you'll pay $8,911 more than you would have without PMI.
As long as the current high lending standards continue, there's no reason to worry
Anytime the down payment standards for mortgages are relaxed, it immediately conjures up fears that the mortgage crisis will repeat itself. It's certainly understandable why people would feel that way -- after all, easy access to mortgages with little or no money down was a major contributing factor to the mortgage meltdown.
However, it's important to point out one big difference. Lending standards have gotten much higher than their pre-crisis levels, and as long as that stays the same, there's no reason to worry about another foreclosure epidemic.
To illustrate this, consider that as of April 2017, the average FICO credit score for an approved conventional purchase mortgage was 753, which is generally considered to be very good credit. Employment, assets, and income are now thoroughly verified, as anyone who has applied for a mortgage within the past eight years or so can tell you. Also, mortgage lenders tend to hold lower down payment borrowers to somewhat higher standards.
The point is, as long as lenders such as Bank of America are maintaining high credit standards and thorough verification practices, a lower down payment won't necessarily translate into an uptick in the loan default rate.
A benefit for consumers and for banks
The bottom line is that lowering the down payment requirement to 10% would make homeownership more affordable to many Americans, could be a positive catalyst to the housing market, and would provide a boost to the mortgage lending business of Bank of America and other mortgage originators.
While there is still some due diligence that would need to happen in order to responsibly relax the down payment requirement as Moynihan suggests, this could turn into a big win for would-be homebuyers and bank investors alike.