The real estate market is good. Rates are affordable. But what could happen in the marketplace if recession hit? In specific, what impact could the plethora of low down payment loans, some made to high-risk buyers have on the number of foreclosures?

While this isn’t a topic you’re likely to think about while relaxing on a Sunday afternoon, it’s lately been one of interest to economists. In view of the recent political battles over Fannie Mae and Freddie Mac (two large players in the secondary market), speculation has fueled about just how harmful an economic downturn would be for the mortgage and real estate industries.

There appear to be three primary factors of impact. First, liquidity in the mortgage market industry has greatly increased in the past decade. Liquidity is the ability of the local lender to sell the mortgage to investors in a timely fashion and return money back to the local level to lend again. Since it’s now easier for lenders to market the mortgages they make, far more loans are being made.

This has been fueled in large part by electronic and technological tools adopted into the mortgage process like computerized loan origination and desktop underwriting that actually saves the amount of time involved in making a loan. Unfortunately, when loans can be made at a rapid pace, corners may be cut. This is similar to the lender I knew who used to say, “What I lose on each loan, I make up for in volume!” (By the way, he’s no longer in business!) Additionally, since the economy has been booming, not only have the number of first time buyers increased, but move-up buyers as well.

Second, the volume of loans is also due in large part to the lowering of down payment requirements in the marketplace. Lenders now make three-percent down payment loans and even some zero-down mortgages instead of the usual ten to twenty-percent down of only a decade ago. In fact, last year Fannie Mae alone purchased $4 billion dollars worth of three-percent down payment loans, up from $100 million made in 1990. While it’s true this helps borrower’s short on cash purchase a home, it also drastically increases the lender’s risk. Statistics show that three-percent down payment loans are foreclosed four times as often as those with ten percent down payments.

High loan volume and low down payments are not the only catalysts contributing to what could become a real estate market fraught with foreclosures during a recession. Higher-risk borrowers have been welcomed into the mortgage market with heavy marketing of the sub-prime loan mortgage product. These loans are targeted to buyers with blemished credit, previous bankruptcies, or foreclosures. While the sheer volume increase of sub-prime loans from $20 billion in 1993 to a whopping $150 billion in 1998 shows there’s a market need for this type of loan, sub-prime loans can default at an even more rapid pace than “A” grade loans, especially if the economy falls into recession.

HUD (Housing and Urban Development) has recently put pressure on Fannie Mae and Freddie Mac in the secondary market to increase their purchase of loans made to lower-income persons, especially in inner-city locations. Meanwhile from the other side, the Fed is issuing warning notices to lenders to tighten their credit requirements to help control the quality of loans closed. At this point, it’s anyone’s guess where the mid-point will settle. Our only hope is that it happens sooner rather than later.

Published: September 22, 2000

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Julie Garton-Good, DREI “The Frugal HomeOwner™” As a syndicated newspaper columnist, author and international speaker, Julie Garton-Good DREI, C-CREC™, is called “America’s Home Affordability Expert”, addressing more than 25,000 persons annually on topics of real estate industry trends and home affordability. She is the author of five real estate books and is the sole two-time recipient of the international "Real Estate Educator of the Year" award from the Real Estate Educators Association. In 1997, The National Association of Realtors® nominated Julie as one of the fifty most influential people in the real estate industry. She shared the list with only three other women.