It seemed an easy fix to prevent the excesses of the housing market: Make homebuyers put more money down.
As the housing market starts to return and the subprime mess fades from memory, however, the issue is up for debate.
Lenders and consumer advocates rarely on the same side of the issue are now cautioning against down payment requirements. They argue that such restrictions could limit lending and prevent lower-income borrowers from buying homes. They also contend that the new mortgage rules put in place this year will do enough to limit foreclosures, making down payment requirements somewhat superfluous.
The arguments seem to run contrary to long-standing beliefs about homeownership. For decades, experts have emphasized the need for a sizable down payment a rule of thumb being 20 percent on the premise that borrowers with a sizable chunk of equity in a home are less likely to walk away when things get bad.
If our goal is to prevent foreclosures, I cant think of anything more effective than requiring a down payment, said Paul S. Willen, a senior economist and policy adviser at the Federal Reserve Bank of Boston,
The issue may not be so black and white. Regulators want to protect borrowers and promote homeownership, but they also want to encourage lending and insulate the financial system from future shocks.
The subprime debacle has distorted the debate, say some analysts. The problem with this conversation is that its like discussing the future of shipbuilding from the deck of the Titanic, said Roberto G. Quercia, director of the Center for Community Capital at the UNC-Chapel Hill. Theres a lack of perspective.
To underscore his point, Quercia studied mortgages in a special program for low-income borrowers, typically those with minimal down payments. From 1998 through the end of last year, 5.5 percent of the mortgages ended up in foreclosure, he found. Subprime mortgages made during the last housing boom, regardless of down payment size, had far higher foreclosure rates, roughly 25 percent.
Its a critical issue for Washington.
Currently, taxpayers, through the Federal Housing Administration, backstop most of the low-down-payment mortgages. The aim is to curb the governments involvement in mortgages.
Advocates say defaults also can be reduced by applying other rules such as those already put in place this year. These regulations emphasize the affordability of the loan. Under them, a borrowers overall monthly debt payments cannot exceed 43 percent of personal income.
Quercias study found that loans that complied with those rules defaulted at a relatively low rate during the housing bust. About 5.8 percent of them went bad, irrespective of how much the borrower put down.
He then calculated the losses on loans to borrowers in the same group who had down payments of at least 20 percent. The default rate on that smaller group was lower, at 3.9 percent.
That lower rate came at a cost, though. More than half of the borrowers in his study group had to be excluded from the second calculation, because they didnt have down payments of 20 percent or more.
But some real estate analysts say debt-payments-to-income ratio is not a strong predictor of whether a loan will default.
They say Quercias analysis underestimates the practical importance of the down payment. Borrowers who saved up for down payments may have budgeting skills that later help them make payments, they say.
Supporters of a down payment requirement also make a broader argument. They point out that the financial sector overhaul was not just meant to protect borrowers. It was also intended to make banks and financial markets more resilient to shocks like housing busts.