For Home Loans, 3% Down is the New 20%

Derrick Reed has had enough of living in an apartment. The 57-year-old retired autoworker used to own a home, he says, but sold it in 2012 after his "health went sideways." He has rented an apartment in Indianapolis since then but wants to get back to the lifestyle he used to have.

"I am not an apartment dweller," Reed said. "I just like having my own space. Even though my neighbors have been pretty good – I don't hear a lot of noise – still, it's not mine."

Reed has zeroed in on a home in the city's Liberty Creek neighborhood that he hopes to buy in about a month. There's only one problem: Reed doesn't have much money saved for a downpayment. "I'm on a fixed income," Reed said, laughing. "I'm getting old."

Many buyers like Reed have been shut out of homeownership in the years since the housing crash. Banks tightened lending standards, making it harder for buyers to qualify for mortgages, and they required higher downpayments. But seven years into the economic recovery, financial institutions are once again making it easier for people to participate in the so-called American dream of homeownership.

Some of the nation's largest banks in recent weeks have trimmed downpayment requirements on conventional loans, without private mortgage insurance, to as little as 3 percent. A few financial institutions are even offering zero-down mortgages. The lending products are geared toward first-time buyers and people with good credit who have had trouble saving money.

Reed is working with Old National Bank to get a mortgage that will allow him to buy the house he wants. Evansville-based Old National has a variety of mortgage products that enable buyers to close for as little as $1,000 out of pocket, thanks to outside grants. Old National works with the Indianapolis Neighborhood Housing Partnership, Federal Home Loan Bank of Indianapolis and the Federal Housing Administration to help buyers get downpayment assistance.

"Even with the job situation changing (during the recovery), for some people, it's just hard to get that savings where you have that 3 percent," said Sherry Boudoin, a loan officer for Old National who specializes in affordable mortgage products. "It's hard to live and also put money aside for the downpayment."

Some of Old National's most appealing mortgage options aren't for everyone, though. The products with the lowest downpayments are geared toward low- to moderate-income or first-time buyers.

3 percent down

But new options are sprouting for people who don't fit into those categories. Wells Fargo, Chase and Bank of America recently launched conventional mortgages requiring as little as 3 percent down – all while avoiding costly mortgage insurance that typically applies to loans with low downpayments.

Bank of America in February rolled out a 3 percent downpayment program that requires buyers to have a credit score of at least 660. To qualify, buyers also must have incomes no higher than the median in their area. The mortgages are backed by Freddie Mac and Self-Help Ventures Fund.

Wells Fargo and Chase followed with similar programs in May, both of which also require a minimum 3 percent downpayment. Unlike Bank of America's 3 percent downpayment mortgage, the Wells Fargo and Chase products don't have income limits. They target first-time buyers, but they're available to virtually anyone with good credit scores.

Wells Fargo's YourFirst Mortgage is an option for buyers who have a 620 credit score or higher. The program can be used to buy houses that cost up to $417,000. Buyers can save one-eighth of a percent off their interest rate if they complete a homebuyer education course. In addition, money for the downpayment and closing costs can come from gifts, a relatively rare allowance for mortgages.

Chase's new plan, called Standard Agency 97 percent, requires a 680 credit score, the highest of the new 3 percent downpayment options. No buyer education course is required.

Mortgages in the 3 percent range aren't new. FHA-backed loans, for instance, have long enabled buyers to get mortgages for as little as 3.5 percent down. But banks recently have soured on issuing FHA loans after being hit with billions of dollars in fines for making what they call minor errors on them. FHA loans also require mortgage insurance, an additional cost, just like many other low downpayment mortgages offered by banks in recent months.

'Higher-risk loan'

Banks are starting to sidestep unpopular mortgage insurance – and the FHA – thanks in part to a 2014 deal with federal regulators in which Fannie Mae and Freddie Mac began backing mortgages that covered up to 97 percent of the value of homes. Fannie and Freddie buy mortgages from lenders and guarantee their values to investors.

The low downpayment trend carries risk for financial institutions and buyers. There is plenty of evidence that low downpayments have higher default rates than loans issued to buyers making the traditional 20 percent down payment, said Daren Blomquist, the vice president of RealtyTrac, a California firm that analyzes real estate data.

"When we break out the foreclosure rates on FHA loans, they are always considered higher than overall loans," Blomquist said. "FHA has a consistently higher default rate over the years, so there's no doubt about it that when you have a lower downpayment, it's a higher-risk loan."

One reason for that: When buyers who make large downpayments fall into financial trouble, they have more equity that enables them to sell, whereas buyers who make low downpayments might owe more money than their houses are worth.

Nationally, the average downpayment on mortgages fell to an all-time low of around 11 percent in late 2008, according to RealtyTrac – just as the housing market was collapsing. As banks raised their standards, the average downpayment ticked up to nearly 16 percent in fall 2013 before starting to slide again. It has been hovering around 15 percent for the past year.

Although low downpayment loans might lead to increased foreclosures, Blomquist said they can't entirely be blamed for the last housing crash and won't singlehandedly cause another one.

"It wasn't just the low downpayment piece of it. It was very lax lending standards and underwriting standards," Blomquist said. "Really, to qualify for loans, homeowners were not even required to document income or debt-to-income ratio, and I believe this time we do have much tighter lending standards in place that are documenting income and holding the line in terms of creditworthiness of buyers."

Raising awareness

Randy Thomas, a sales manager in Indianapolis for Wells Fargo, said the bank's new 3 percent down product is a way of helping first-time buyers, as well as people who got pummeled during the recession and have found their way back into steady employment.

"There are people that had some challenges during the years since 2008, and people fell on hard times," he said. "They're trying to get re-established and get back to homeownership."

One challenge so far, Thomas said, has been educating people that mortgages are available for downpayments of less than 20 percent.

"They're not aware of all the other alternatives and opportunities," he said.

A few financial institutions have brought back zero-down mortgages. Navy Federal Credit Union, which serves members of the military and their families, has offered a zero-down mortgage since 2005. The credit union stopped marketing it for a couple of years during the recession but has been touting it again since 2010.

Zero-down mortgages account for 10 to 15 percent of Navy Federal's home loans each year, said Katie Miller, the credit union's vice president of mortgage lending. Fewer than 1 percent of them default, Miller said.

Financial institutions that are offering the lowest downpayments on conventional loans tend to have one thing in common: They're big. Navy Federal is among the nation's largest mortgage providers, and Bank of America, Wells Fargo and Chase are among the so-called systematically important financial institutions (SIFI), a term that refers to the largest of the financial giants.

"The 3 percent down mortgage strikes me as unfair competition by SIFI institutions," said Charles Trzcinka, a finance professor at Indiana University's Kelley School of Business. "The federal government will buy many of these mortgages, but banks will still take the risk of issuing mortgages that have a higher failure rate. They will obviously take the default risk if they hold these mortgages and don't sell them. The clear reason why they are doing it is the higher interest that they will get."

Smaller banks such as Old National must get creative to compete with the giants, helping buyers apply for grants and housing programs to spend as little as possible upfront.

Reed, who hopes to buy a house in Liberty Creek, doesn't necessarily care which mortgage program he uses. He chose Old National because the process seemed comfortable, he said.

Reed is hoping to spend about $105,000, a more modest amount than he spent on his previous house, he said. He wants to be responsible. He just needs a little help getting the key.

"We're close," Reed said. "I just want to close as soon as possible, because I'm tired of paying rent on an apartment."

Copyright © 2016 The Indianapolis Star, James Briggs. Distributed by Tribune Content Agency, LLC.  Source