HomeReady

Monday 12/07/15

     This week I want to look at a bizarre development in the home lending market. Fannie Mae, the largest buyer of mortgages who went into government conservatorship after the housing collapse, just launched a new lending program called HomeReady. The HomeReady program allows borrowers to purchase a home with as little as a 3% down payment; this is even lower than the downpayment on an FHA loan. However, what makes the HomeReady program even more interesting is that Fannie Mae will now consider non-borrower income. This week we'll look at the details of the HomeReady program and why I think it is a bad idea.

     The minimum downpayment is only 3%, but the borrower does not have to pay any of it. The money could come from a family member or from another loan. In fact, many non-profits and local government organizations are offering subordinate loans that allow the borrower to pay nothing at all out-of-pocket.

     Having skin in the game is an essential part of home lending. In 2008, when house prices were falling, recent borrowers went upside down on their mortgages, meaning that they owed much more than the actual value of the home. Since these homeowners did not have much skin in the game, many simply walked away from their mortgages which caused home prices to fall even further. With no downpayment, homeowners will start out with no skin in the game.

     The HomeReady program also allows the borrower to include income from non-borrowers such as family members, renters or non-borrower roommates. This income can be used to increase the borrowers debt-to-income ratio to 50%. The non-borrower is not under any legal obligation to pay the mortgage or stay in the property, they simply have to say that they intend to live there for 12 months.

     The minimum credit score on a HomeReady mortgage is 620 which is already low, but applicants who do not meet this minimum because of non-existent or insufficient credit history can still be approved. The lender can fill out a non-traditional credit profile to qualify the borrower.

     With this mortgage a borrower with no credit history can take on a large amount of debt with no down payment to buy a home that they normally wouldn't be able to afford by relying on income from someone with no skin in the game. Do you see a problem? I suspect that this will lead to increased volatility in home prices, not just on the downside but also on the upside. A huge wave of customers who couldn't afford homes will now be bidding up home prices, and when the market turns borrowers with little skin in the game will add to the downward pressure. The difference between wages and home prices is just as bad as it was during the last housing bubble as you can see in the chart on the right.

     The supposed intention of the HomeReady solution is to help low income multigenerational households, but I don't think it will. This could have the opposite effect where it makes housing even more unaffordable as speculators bid up the prices of homes in these areas. The number of people living in the same home has increased in recent years because homes have become unaffordable in many places. The solution should not be to increase the debt burden of low-income families, but rather to encourage responsible lending practices.