Why We Shouldn’t Fear Low Down Payments

Although some studies have supported these views, the CRL argues that the push for bigger down payments unfairly blurs the line between low-down-payment loans and subprime loans made to borrowers with poor credit. The number of subprime loans soared during the housing boom, contributing to the bubble, and subprime borrowers later defaulted at unusually high rates.

“In fact, low-down-payment home loans have been a significant and safe part of the mortgage finance system for decades, bearing little resemblance to subprime and other alternative mortgage products that crashed our economy,” the CRL said. More than 27 million low-down payment loans were issued from 1990 to 2009 without resorting to the risky features of subprime loans, the CRL added. “Low down payment” is defined as less than 20% down.

While subprime loans typically required low down payments, they were very different from conventional low-down payment loans in other respects: they often had no requirement that the borrower document income and assets, did not include an evaluation of the borrower’s ability to repay, permitted applicants to borrow much more relative to their incomes and often involved shoddy property appraisals.

“Subprime loans’ risky loan terms and weak underwriting standards have resulted in record default rates,” the CRL said. “In contrast, research has shown that significant reductions in default rates are achieved by full underwriting documentation and reasonable debt-to-income ratios.”

Loan defaults are likely to be reduced by the tougher underwriting standards required in last year’s Dodd-Frank financial reform law “without having to add on additional higher down payment requirements,” the CRL concluded.