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Why 3% Down Mortgages Alone Won't Revive Housing

In the world of mortgage financing there is stuff that's seen and stuff that's not. Lowering down payment requirements from 5% to 3% will surely help some prospective buyers. However, in a world with roughly 4% interest rates and average sales prices that remain 11% below their 2005 peak, down payments are not the only issue to solve.

The government-sponsored enterprises have begun to accept loans with 3% down, but they're not just any old 3% loan. The GSEs want something more, and that "something" is 18% mortgage insurance coverage.

Combine the 3% down payment and the 18% insurance requirement, and Fannie Mae and Freddie Mac are following long-time industry standards by requiring at least a 20% cushion in case something goes wrong.

And while mortgage insurance is a burden, the bigger obstacle to focus on, according to a RealtyTrac home affordability analysis, is non-household debt.

In 92% of the counties analyzed, payments on a median-priced home required less than 43% of median household income, which is the maximum debt-to-income ratio allowed for a qualified mortgage by the Consumer Financial Protection Bureau.

Add in the typical student loan debt and car payment, and less than half — 48% — of U.S. housing markets are affordable for median-income earners using the 43% DTI.

Additionally, the standards for 3% loans is hardly straight-forward, meaning they are not for everyone.

For instance, Fannie Mae's MyCommunityMortgage program is only available if at least one borrower is a first-time home buyer who has completed pre-purchase education and counseling. The loan must have a fixed rate and be secured with a one-unit principal residence — meaning that duplexes, triplexes and quads are off limits. Manufactured housing is also ineligible. However, gifts can be used to bulk-up reserves, a new wrinkle. The program can also be used to refinance existing Fannie Mae loans and cash-out refinancing is also allowed.

Over at Freddie Mac, Home Possible Advantage loans are the mirror-image of the Fannie Mae mortgages. For instance, HPA mortgages can be used for a purchase or a "no cash-out" refinance transaction. There's an educational requirement and only prime residences can be financed. Adjustable-rate mortgages are now permitted.

The 3% loans are also unlikely to have much impact on refinancing. With less down — really, with less equity for refinancing — there should be more refinancing demand and some additional refinancing activity will be attributed to the new products. Refinancing demand is largely a byproduct of interest rates and lower monthly costs. For most homeowners, that financial ship has sailed.

Most eligible borrowers have already refinanced into lower rates and an estimated 80% of outstanding loans have a mortgage rate of 4.5% and lower, according to the Mortgage Bankers Association. Within the remaining 20%, many are likely to remain underwater, or do not have the income or credit to refinance.

Loans with less down are certainly attractive and unquestionably will lure some additional borrowers into the housing market. It's a help, but just a smidgeon of help. The new programs are being introduced at a time when mortgage rates are low and prices are generally attractive, but such enticements have not resulted in soaring sales, something unlikely to happen until the economy picks up, incomes grow and job stability becomes more certain.

If, as widely predicted, mortgage rates and home prices rise later this year or early in 2016, the benefits of a lower down payment will be offset by higher costs. For many buyers, the trade won't work.

Brian Mushaney is Executive Vice President of Data Solutions at RealtyTrac.

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