How Important Is Down Payment in Determining Default?

Source: DSNews.com

The Federal Housing Finance Agency (FHFA) recently released a working paper on the impact of down payment amounts on loan performance at the GSEs and Federal Housing Administration (FHA). In light of new regulations and increased focus on underwriting standards, the agency issued the findings, and overall found a nonlinear relationship between loan-to-value (LTV) ratio and foreclosure rates.

Making sense of the story

• For loans with FICO scores of 620 and debt-to-income (DTI) ratios of 31 percent, the foreclosure rate for GSE loans with 100 percent LTV is a little more than twice that of loans with 80 percent LTV.

• When it comes to FHA loans with the same credit characteristics, the foreclosure rate is almost three times as much among loans with LTVs of 100 percent compared to loans with LTVs of 80 percent.

• LTV ratios hold a stronger relationship with foreclosure rates among FHA loans than GSE loans.

• The FHFA found that the LTV-foreclosure rate relationship is sensitive to FICO. This finding was evident when observing various LTV ratios among different classes of FICO scores.

• According to the FHFA, once LTV rises above 95 percent, the foreclosure rate tends to correlate less with LTV ratio.

• The relationship between LTV and foreclosure is most dramatic between LTVs of 90 and 95 percent when it comes to FHA loans.

Amid new regulations and increased focus on underwriting standards, the Federal Housing Finance Agency recently released a working paper on the impact of down payment amounts on loan performance at the GSEs and Federal Housing Administration (FHA).

Overall, the federal agency found a nonlinear relationship between loan-to-value (LTV) ratio and foreclosure rates.FHFA also determined that credit score plays an important role alongside LTV ratios in determining the likelihood of foreclosure.

LTV ratios hold a stronger relationship with foreclosure rates among FHA loans than GSE loans, according toFHFA. “The implication is that the same level of change in original LTV requirement would have a larger impact forFHA borrowers than for GSE borrowers,” the FHFA stated in its working paper.

Among loans with FICO scores of 620 and debt-to-income (DTI) ratios of 31 percent, the foreclosure rate for GSE loans with 100 percent LTV is a little more than twice that of loans with 80 percent LTV.

For FHA loans with the same credit characteristics, the foreclosure rate is almost three times as much among loans with LTVs of 100 percent compared to loans with LTVs of 80 percent.

When observing various LTV ratios among different classes of FICO scores, FHFA found, “the LTV-foreclosure rate relationship is sensitive to FICO.”

For example, raising LTV from 80 percent to 90 percent on a loan for a borrower with a FICO score of 620 increased the likelihood of foreclosure by 4.46 percentage points.

Making the same change in LTV to a loan for a borrower with a FICO score of 700 increased the likelihood of foreclosure by half that—2.23 percentage points.

For FHA loans, which are more sensitive to changes in LTVratio, the relationship between LTV and foreclosure is most dramatic between LTVs of 90 and 95 percent. This trend carries across all FICO scores observed.

Once LTV rises above 95 percent, the foreclosure rate tends to correlate less with LTV ratio, according to FHFA.

Meanwhile, DTI ratio correlated strongly with foreclosure rate. “As expected, across all LTV levels, borrowers with a higher DTI had a higher foreclosure rate,” FHFA stated.

However, the “LTV-foreclosure rate relationship has a relatively modest sensitivity to the DTI level,” FHFAfound.

When comparing LTV rates among delinquency rates,FHFA found similar relationships to what it found among LTVs and foreclosures.

What to do when an appraisal comes in below the selling price

As the real estate market heats up and prices continue to recover, more home buyers and sellers are likely to encounter the problem of an appraisal that is lower than the agreed-upon sale price.

Making sense of the story

 Appraisals must be based on recently settled transactions, and in a rising market those past transactions are likely to be lower in price. Whether a buyer or seller, it’s important to understand the risks involved around low appraisals – and the options available.

 Because of new restrictions on the relationship between lenders and appraiser – aimed at curbing the appraisal abuse that contributed to the housing bubble – buyers and their mortgage representatives have less control over the process. Lenders simply order an appraisal from a list of approved appraisal companies, and a third party directs the individual to perform the appraisal.

 Resulting from the third-party rules, the appraiser who is assigning a value to the home may not be from the immediate area. It can help to inform the appraiser of the quality of the school district or the amenities in the local neighborhood, as well as improvements to the property as compared with other recent sales in the area.

 One appraiser recommends sellers prepare a package of information on the home, including data on comparable houses and any improvements that have been made that should influence the value of the home.

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