Are Loans With 3 Percent Down Going Away?

Rumor has it that mortgages with 3 percent down are not far from extinction, but can that really be true?

If you want to buy with little down then the choices today include VA loans with nothing up front, FHA financing with 3.5 percent down and community homebuyer loans with as little as three percent down.

Given that lenders prefer 20 percent up front, mortgage loan options with low-to-no down payments are made possible with the use of mortgage insurance: the VA charges an up-front guarantee fee, the FHA has both an up-front and an annual mortgage insurance premium (MIP) and conventional (non-government) lenders require private mortgage insurance (MI).

But now there is some question as to whether conventional loans with as little as three percent down will continue to be available.

Should Community Homebuyer Loans Get the Axe?

"Fannie Mae," reports the Wall Street Journal, "is in discussions to curb its purchases of mortgages that require a minimum down-payment of 3%, according to people familiar with the discussions."

The usual argument to require more cash up front concerns risk. The idea is that borrowers who -make a larger down payment are less likely to default, thereby making mortgages less risky for investors. But the fact is that loans with low down payments perform quite well. Indeed, the Journal notes that possible Fannie Mae "changes aren’t being made because of concerns about loan performance."

Perhaps the best example of low-risk loans with little down comes from the VA mortgage program. According to the most-recent numbers released by the Mortgage Bankers Association, VA loans (2.08%) have the lowest foreclosure inventory rate at 2.08%. That's lower than prime (2.62%), FHA (3.85%) or subprime (11.01%).

So it turns out that the loans which allow zero down have the lowest foreclosure rate. How can that be? In the case of the VA it's likely to be the result of a special underwriting requirement to compute what's called the "residual income" factor -- in other words, how much cash is available to the borrower based on household size and geographic location, after housing costs.

Community Homebuyer Loans Support the Housing market

There is a real reason to make sure that loans with little down remain available: They make buying a home easier and that brings more people into the real estate marketplace. If more people are vying for homes, prices tend to be stronger.

If Fannie Mae can no longer buy loans with three percent down, it means that such financing will be much harder to find. Instead, the idea should be to make access to mortgage financing as attractive, low risk and inexpensive as a competitive marketplace can allow. Especially now, when mortgage rates are as low by historic standards as they are, it would be a bad time to limit access to home loans which require little cash up front.

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