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Housing Perspectives

Research, trends, and perspective from the Harvard Joint Center for Housing Studies

How the Presence and Type of Down Payment Assistance Affects the Performance of Affordable Mortgage Loans

Even though Fannie Mae and Freddie Mac returned to very-low down payment lending following the financial crisis, saving for a down payment remains one of the biggest barriers to obtaining a home mortgage. What is most striking about this return to high-leverage home lending is the proliferation of more than 2,500 privately sponsored and government-funded down payment assistance (DPA) programs across the country, which have the collective effect of reducing first-time homebuyers’ contributions from as little as 3 percent to something substantially less.

An indication of how important DPA has become to reaching the first rung on the homeownership ladder is that in FY2018, approximately 43 percent of FHA first-time homebuyers relied on some form of down payment assistance, while for 18 of the 44 housing finance agencies rated by Moody’s, more than 90 percent of all production is now DPA-driven. Although research generally finds higher loan-to-value ratios increase default risk, few if any studies address the question of whether DPA in conjunction with very-low down payment purchase loans increases default risk to the point of warranting some form of corrective policy action, which is why HUD’s ongoing efforts to limit the sources and sponsors of DPA is so important.

Specifically, citing generally higher early payment defaults (EPD) and serious delinquency rates (SDQ) for loans with DPA compared to those without DPA, HUD has announced that it is reserving DPA loans for special scrutiny where assistance is funded by a government program rather than from a relative or other source, because they perform the most poorly. FHA will evaluate this latter type to determine “whether its current premium structure is commensurate with the risk the taxpayers are taking on.”

A serious limitation of HUD’s analysis is that it fails to take account of other risk factors unrelated to down payment assistance, such as the borrower’s demographic attributes, including credit score, which could lead to poorly designed and racially punitive corrective action.

In this context, a newly-released paper I co-authored with Sarah F. Riley and Roberto G. Quercia, A Cautionary Tale of How the Presence and Type of Down Payment Assistance Affects the Performance of Affordable Mortgage Loans, sheds light on the relationship between different forms of DPA and default risk using multivariate methods applied to a well-documented national affordable lending data set from the Community Advantage Program (CAP). Despite HUD’s stated concerns, my colleagues and I find that the receipt of down payment assistance is not significantly associated with default risk.

Other significant findings from our paper are:

  • Blacks are significantly less likely than whites to have received assistance from family or friends, but significantly more likely than whites to have received assistance via a second mortgage, or to have received a government or community grant;
  • In contrast to what is found by a simple descriptive analysis, the receipt of DPA is not significantly associated with default risk; and
  • Grant assistance from a government or community organization has a marginally significant association with default risk but this effect disappears when racial controls are incorporated in the model.

This finding is significant because of the importance of DPA to minority borrowers, especially assistance in the form of grants and loans from government programs, rather than from friends and family. Since we find that CAP households with DPA were as able to benefit financially from rising markets as those without DPA, in setting guidelines around down payment assistance, policy makers should take care not to close off opportunities to aspiring minority homebuyers.