Housing Bubble 2.0? Cheap Financing Comes Back Into Style

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Most Americans remember all too well the housing bust and subsequent financial crisis, which left millions of homeowners owing more on their mortgages than their homes were worth and made it nearly impossible for many people to sell without taking huge losses. In the past five years, housing prices have recovered considerably, but tougher lending standards have left many would-be homeowners unable to buy. That's the rationale behind the latest move from government-sponsored mortgage-lending enterprises Fannie Mae and Freddie Mac that opens the door to buyers getting into the home of their dreams with as little as 3 percent down.

Most policymakers see encouraging home ownership as a positive thing. Yet given the role that cheap financing had in the first housing crisis, the obvious question is whether low-down-payment programs will bring on another unsustainable housing bubble.

What the New Programs Let You Do

Earlier this month, Fannie Mae and Freddie Mac released the details on loan programs that would allow borrowers to get loans of as much as 97 percent of the value of the homes they want to buy. In its press release, Fannie Mae noted that the goal of the program "is to help additional qualified borrowers gain access to mortgages." Citing barriers that have impeded homebuyers from gaining access to the credit they need in order to finalize their purchases, Fannie Mae asserted its confidence that 97 percent loans "can be good business for lenders, safe and sound for Fannie Mae, and an affordable, responsible option for qualified borrowers."

Under both programs, at least one of the borrowers on a new-purchase loan has to be a first-time homebuyer. Borrowers must have a credit score of at least 620, and they need to buy private mortgage insurance and show their financial eligibility for a mortgage. The properties involved must be single-family residences and cannot be manufactured homes. Adjustable-rate mortgages aren't allowed under the program, and fixed-rate mortgages can't have terms longer than 30 years. In addition, the borrowers have to certify that they've participated in a home-buying educational program.

Fannie Mae has also opened the possibility of allowing cash-out refinancing transactions that would bring outstanding debt up to 97 percent of the home's value. To qualify, Fannie Mae must already own the existing mortgage loan, and borrowers must meet most of the other eligibility requirements of the purchase-loan program.

What's the Risk?

The obvious concern among those who oppose the latest moves to loosen credit standards is that allowing smaller down payments makes it easier for borrowers to get in over their heads with the mortgage loans. Given that home prices fell by more than 30 percent from 2006 to 2009, according to the Case-Shiller Home Price Index, having just a 3 percent reserve leaves homeowners extremely vulnerable even to a more modest future decline. Even Robert Shiller, who helped create that home-price index, has said that lenders and the government-sponsored entities are taking on more risk with 97 percent loans than they might realize.

To their credit, Fannie Mae and Freddie Mac appear to be sensitive to the risks involved and have taken explicit steps to limit any downside from a future housing-market downturn. In particular, the government-sponsored entities have made it clear that private lenders using the program remain exposed to initial losses under these loans, therefore encouraging banks and other financial institutions to use good judgment in vetting these loans despite having the guarantees provided by Fannie Mae and Freddie Mac. Moreover, banks will know under what conditions the government-sponsored entities can force them to buy back a bad loan, hopefully preventing the massive multibillion-dollar lawsuits involving loan repurchases following the financial crisis.

Still, it's hard to understand why new 97 percent mortgage loans will have such a markedly positive impact on the housing market. Already, the Federal Housing Administration has programs that allow 3.5 percent down payments, and other government programs exist that extend 100 percent financing to veterans or to low- and moderate-income homebuyers who live in rural or suburban neighborhoods. Presumably, the Fannie Mae and Freddie Mac programs are intended to reach a larger audience, but it's uncertain how many would-be homebuyers would get the additional motivation from these programs to move forward with a home purchase.

In itself, an initiative to help first-time homebuyers isn't likely to cause the next housing bubble. But as the next step in a progression toward making credit standards less strict, the moves could end up being seen as the catalyst that could lead to another explosive rise in credit availability -- that eventually could end in disaster once more.

Motley Fool contributor Dan Caplinger is a big believer in a big down payment. You can follow him on Twitter @DanCaplinger or on Google Plus. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.
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