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Special Reports
Downpayment Assistance
Retsinas: Low Downpayments Risky for Borrowers
By Amilda Dymi
CAMBRIDGE, MA -- Mortgage product proliferation has introduced new loan options,
many of which have adjustable rates and require low or zero downpayment, transferring risk, especially interest
risk, directly onto the customers' shoulders, experts say, thus reversing an old trend where loan risk is faced
primarily by investors.
"A plethora of mortgage products has been developed over the last decade.
All of them pretty much involving lessening the requirement for downpayment," Nicolas Retsinas, director of
the Joint Center for Housing Studies at Harvard University here, told ON. "But the price for some of these
mortgage products is the borrower assuming increased risk. Increased risk in terms of rising interest rates, increased
risk because if there is a downturn in the market, will they be able to sustain their payments?"
He believes the irony of this situation is in the shift. "We have had a generation
of products in this country where most of the interest rate risk has been borne by the investor, particularly through
the long-term fixed interest rate mortgage," he explained. "Now it seems that we are moving it rapidly
to the borrower."
More specifically, borrowers and the mortgage industry need to be more aware of
risk associated with interest-only and low-downpayment products, even though the housing sector continues to be
very strong, according to "State of the Nation's Housing Report 2005" data released by the joint center.
Along with the unprecedented expansion of the subprime market, these new products are contributing to both higher
homeownership rates and higher long-term risk.
"There are lots of reasons why the housing market is so strong and lots of
reasons to believe that it will continue to stay strong, particularly because of the demographic pressures that
exist," Mr. Retsinas said. "At the same time ... some of the new risk is related to two different types
of issues. The rapid escalating price appreciation that continues in many markets and at some point it has to be
a re-calibration, a balancing if you will, of prices and income, because you have to be able to afford the prices."
Furthermore, the industry has to become more aware of product-related risk.
Since, as a rule, not everyone gets increases in wages, or increases are not as
significant as house price appreciation rates, "there always is the risk of [customers] not being able to
make their payments," he said. "Now there is an added risk coming from all these new products, especially
the interest-only products" that are becoming more popular.
"Basically you're taking out the interest to a mortgage. You're calling on
increased appreciation. But the IO mortgages are almost always adjustable. Therefore, you continue to bear that
rate change associated risk," he explained.
Finally, making the customer bear the interest risk is in itself added risk.
"One of the real hallmarks of housing finance in this country is that shifting
of the interest rate risk. I do believe investors are better able to assess and price interest rate risk than borrowers,"
he said.
Many lenders, especially the large banks, are offering new, no or little downpayment
products.
In 2004, HUD and the FHA proposed DPA legislation that did not pass. This year,
he said, that legislation is being reintroduced, but he is skeptical.
"I haven't seen the proposal, but still there is no particular reason to
believe it will be different than last year."
The best way 10 years ago to predict whether someone would repay a loan was by
looking at the size of their downpayment, he said. The larger the amount down, the smaller the risk of them not
paying off their loan. This evaluation has been replaced by credit assessments, which is believed to be a better
tool.
"The difficulty however is that credit scores have performed very well in
a housing market that continues to prosper. The jury is still out on how well they will perform if the market starts
to struggle, or the economy goes not into the mild recession we've seen, but into a deeper recession," Mr.
Retsinas said. "Then we don't know what is going to happen, if you do not have the cushion of downpayment
behind you."
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