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3 Percent down payments and risk to lenders

December 14, 2014
Read Time: 0 min

Many would point to imprudent lending standards as a leading cause of the financial crisis of 2008, and in turn, financial institution regulators have since bolstered lending standards and capital thresholds as a preventive measure against a similar crisis.

But recent news from Fannie Mae and Freddie Mac might suggest that the market is inching closer towards pre-recession lending practices.

Mortgage companies Fannie Mae and Freddie Mac announced earlier this month they will now offer programs that guarantee loans with down payments as low as 3 percent of the principal. The objective of the programs is to increase credit access for low and middle income families and many first-time homeowners. This class may have struggled in the past to meet the minimum down payment required for traditional mortgages.


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The program does require that borrowers meet a minimum credit-score threshold, provide documentation showing income and job status and buy private mortgage insurance as added steps to mitigate risk.

The National Association of Home Builders (NAHB) Chairman Kevin Kelly applauds the new programs in a recent statement:

“NAHB commends Fannie Mae and Freddie Mac for instituting new loan guidelines that will allow creditworthy borrowers to obtain mortgages with a downpayment of 3 percent. One of the biggest obstacles to achieving homeownership is the ability to come up with a downpayment. By reducing upfront cash requirements while establishing tough but fair underwriting guidelines that include a number of safeguards, Fannie and Freddie will open the door to homeownership for more American families, particularly first-time home buyers and younger households.”

While the objective is undoubtedly a positive step for borrowers needing access to capital, there are some concerns that the new LTV for these loans introduces additional risk for lenders who underwrite the loans. Should the borrower default on the loan with only 3 percent paid down, it is more likely or possible that the bank will fail to recoup the full amount - a problem that became all-too-real for banks during the financial crisis.

For institutions that choose to lend with these standards, there are additional steps the institution can take to strengthen risk management practices. Alongside the lower down payment, lenders can increase documentation requirements (for example, verification of income) as a precaution and perform additional stress tests to contingently plan for capital in the event of a downturn.

Stress testing the portfolio won’t prevent the risk that comes with this standard of lending, but it can help the institution plan for it. For more information on stress testing, download the whitepaper: Stress Testing: The Who, What, When and Why.

About the Author


Raleigh, N.C.-based Sageworks, a leading provider of lending, credit risk, and portfolio risk software that enables banks and credit unions to efficiently grow and improve the borrower experience, was founded in 1998. Using its platform, Sageworks analyzed over 11.5 million loans, aggregated the corresponding loan data, and created the largest

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