Defining the American Dream

Fed Study Reveals Down Payments Help Prevent Defaults

Posted on Thursday, March 17, 2011

Research released this week by the senior research economist at the Federal Reserve Bank of Cleveland reveals homeownership is more sustainable for people who come to the table with down payments.
The study examines the types of homeowner assistance that the government uses to promote homeownership — generally down payment subsidies or interest rate subsidies. The study compared the impact of mortgage rates and down payments on defaults, using two hypothetical government programs that either subsidized rates or down payments.
A writeup of the study notes, “the goal of these hypothetical programs was not just to make low- and moderate-income people homeowners but to make sure that they could sustain their homeownership.”
Economist Emre Ergungor says of his findings, “[Down payment subsidies] create successful homeowners – homeowners who keep their homes — at a lower cost.”
His study estimated the cost of reducing the likelihood of mortgage defaults by the same amount in each program.
He found that “to achieve the same reduction in default risk from a 1 basis point decline in mortgage rates, low- and moderate-income homebuyers would need a supplemental down payment of $32.”
Ergungor’s study points out that homeowners who supply down payments start out with equity in their homes, equity which is associated with beneficial outcomes, like having more flexibility if moving is necessary.
“First,” says the study, “a substantial equity position reduces the chances of default. So even if adverse changes to some homeowners’ finances had forced them to exit homeownership during the time housing prices were falling so sharply, their equity would have given them options that made default less appealing.”
Another benefit of down payments is that people with equity in their homes are more likely to maintain the property.
On the other side, subsidizing the mortgage rate is not as beneficial, says the study. A lower mortgage rate would help to make payments more affordable which might lower the chance of default, but if the homeowner falls on hard times, a good interest rate will not help them.
Not only that, the study also points out that a lack of down payment is one of the biggest barriers to people who want to become homeowners.
“More people decide to become homeowners when the down-payment restrictions are eased than when mortgage rates are reduced,” says the study.
It continued, “My calculations using the findings of previous researchers suggest that a 1 percent interest rate subsidy may create an additional 74,000 homebuyers, but down-payment assistance of $3,200 could attract 541,000 new homebuyers.”
By: Joy Leopold, DS NEWS



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