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Low Down-Payment Mortgages on Way Out : Secondary Market Wants Less Risk in Home Loans, Mortgage Bankers Conference Told

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The 10%, as well as the 5%, down payment may disappear as a result of default and foreclosure concerns by lenders and investors in the secondary market for mortgages, which now purchases more than one-third of all residential mortgages.

That trend away from low down-payment mortgages was made clear by primary and secondary mortgage market officials at the Mortgage Bankers Assn.'s three-day National Secondary Market Conference here.

Mortgage originations, driven by refinancings, should reach at least $300 billion this year, and housing will be “one of the strongest sectors in the economy,” economist Kenneth T. Rosen of UC Berkeley predicted.

Rosen, chairman of the university’s Center for Real Estate and Urban Economics, said this compares with an estimated $230 billion last year, $200 billion in 1984, and only $90 billion in 1982.

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Defining High-Risk Loans

Elaborating on a trend toward higher down payments, Karen Eissner, director of quality control at the Federal Home Loan Mortgage Corp., or Freddie Mac, one of three public conduits that purchases and pools mortgages for sale to the secondary market, said her agency now classifies all loans made for 90% or more of the purchase price as being high risk.

As such, a large number of those loans are pulled for special review and may not be purchased, she explained.

Loans made for 80% to 89% of home value are listed as medium risk, while low-risk loans are only those made for less than 80% of home value, Eissner reported.

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The Federal National Mortgage Assn. also is turning away from mortgages with down payments of 19% or less, preferring those with down payments of at least 20%, according to Judith Dedmon, vice president for quality standards at Fannie Mae, as the agency is known.

Rosen said only 13% of all homes purchased last year were bought with down payments of 10% or less. “That number should run about 10% this year,” he predicted.

Parental Assistance

“This creates a real affordability problem for the first-time home buyer,” Rosen pointed out, saying that tapping their parents for part of the down payment might be the only way they could enter the housing market.

Rosen said that more than one-third of this year’s loan volume will be sold in the secondary market. But other speakers, including J. Timothy Howard, senior vice president and chief economist at the Federal National Mortgage Assn., predicted that half of this year’s mortgage volume will be sold as mortgage-backed securities.

“We’re already running at a pace that will exceed that,” Howard said.

MBA President Ronald F. Poe, president of Dorman & Wilson Inc., White Plains, N.Y., predicted that secondary market sales will reach $175 billion this year.

Last year, only slightly more than $100 billion of mortgages were securitized.

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“The secondary market has become the primary market,” declared Warren Lasko, executive vice president of the MBA. “That’s absolutely good news.”

Home Sale Forecast

Other “good news” reported at the conference included continued low inflation and interest rates, a rise in the gross national product, a continued slowing of the rise in the federal deficit and strong housing activity in most parts of the nation, except the upper central states and Texas, Oklahoma and Louisiana, with the maturing of the baby boom generation still being felt.

Lasko said that although new-home starts have been “disappointing,” with interest rates down, sales of new and existing housing will pick up this year. And rates should drop further “if the markets can be convinced that inflation is under control,” he added.

Howard forecast a growth in the GNP of 3% or less during the first half of 1986, rising to 3.5% to 4% by the end of the year, while inflation runs in the 2.5% to 3% range for the year. He said that the outlook for the budget deficit is “much more favorable than six months ago.”

Rosen said he sees “booming” housing activity in the Northeast while activity will continue the same as in 1985 elsewhere, with starts in California remaining at about 260,000. Looking at five-year growth, from 1986 to 1990, Rosen included three California metropolitan areas among the nation’s top 10--San Diego, Anaheim-Santa Ana and Riverside-San Bernardino.

Texas Hard Hit

Housing prices will rise at a rate twice the rate of inflation, he predicted, “a big change from where we were.”

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Rosen’s bleakest view was directed at Houston which he said faces a five-year work-out period. “The full tragedy of Houston has not been fully revealed,” he said.

William R. Thomas, executive vice president for operations at FHLMC, said that foreclosure problems in Texas, which has the largest number of foreclosed properties in the nation, are “spilling over into Oklahoma and Louisiana,” while problems in the Northwest are leveling off and improving in the Southeast and in the Rust Belt.

Lasko said that as the “baby bust” generation begins moving into its house-buying years in five years, the demand for move-up and retirement housing will increase. “There simply will be an adjustment in the way we market.”

But to home buyers not all of this amounted to good news.

Returned to Market

Investors, on whom the secondary market relies, began deserting that market when interest rates fell and homeowners began prepaying their high-rate mortgages, cutting the yields that had exceeded that of Treasury bonds, Howard explained.

They, mostly life insurance companies and pension funds, are returning now because mortgage rates have not fallen as much as Treasury rates and because the prepayment risk has disappeared at today’s low rates.

Michael J. Lea, chief economist for the Federal Home Loan Mortgage Corp., which, like FNMA, buys and pools mortgages for sale in the secondary market, also said that mortgage interest rates will not decline as much as the rates on long-term bonds because of investor concerns.

“They will demand more yield because of what they see as increased risk,” he said. “Investors also will look to mortgage-backed securities with additional call protection,” he added, referring to a means of limiting prepayments.

Refinancing Existing Loans

Refinancings will continue to increase this year, but will drop next year, causing an overall decline in mortgage activity, Lea predicted.

Rosen said that with mortgage interest rates below 10%, “anything over 12% is likely to be refinanced.”

That represents about $85.5 billion worth of loans, or 24.9% of all outstanding loans, he calculated.

In another negative development, the roles of the Federal Housing Administration and Veterans Administration in the housing market also will shrink.

Glen S. Corso, the MBA’s senior staff vice president for government agency relations, said he anticipates that in “the next 60 to 90 days, FHA and VA will reach the top of their congressionally set commitment ceilings” and there will be “a temporary interruption of FHA and VA ability to make commitments.”

However, Corso said he expects Congress will increase those limits to accommodate the amount of mortgage activity being conducted.


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