Zero-down Loans? Again?

Saw this article on CNN today talking about zero-down loans. https://www.cnn.com/2024/06/03/business/zero-down-mortgage-nightcap/index.html

So FNMA has this program where borrowers can get 97% LTV loans - https://singlefamily.fanniemae.com/originating-underwriting/mortgage-products/97-loan-value-options and borrowers can get down payment assistance for the remainder and any closing costs from 3rd parties. So yes, the government has a zero-down program for 1st time home buyers.

So this mortgage company has come up with a product where they will loan buyers (on an interest-free basis) up to $15,000 to cover the remaining 3% (a second loan). The borrower can thus get a zero-down loan.

Most of you might remember what happened during the 2008 sub-prime crisis (or at least you might have seen the Big Short at some point). In a nut shell:

1. Alt-A and Sub-prime lending: These were low docs or no docs deals often with stated incomes as opposed to sharing w-2, bank statements etc.
2. Zero-down or near zero-down loans: 1st mortgage of 80% and a second mortgage of 15%, and some handshake deal for the remaining 5%.
3. IO/Low intro rate ARM/Neg-Am Loans: From 2006 until the full-bloom crisis of 2008, we saw several financially engineered products to keep the party going: neg am products took the cake - you pay less than you owe so instead of your outstanding principal balance going down like with normal mortgages, it actually kept going up with these!

Why do I worry about these types of products?

On the surface, there's a feel good story - creating a path to homeownership for lower income households and first-time home buyers. But we need to look at the past and take a page from the history books. In times of financial stress, lower income households (without adequate savings) will be disproportionally impacted (e.g., loss of job, unexpected medical expense etc). When this happens, the loan will very likely go into delinquency. If property prices go up over the next few years, the borrower will end up with equity. However if they don't, a borrower with no equity may be tempted to walk away, or worse still, the mortgage servicer would need to look at loss mit strategies like forbearance, loan modification, deed in lieu (cash for keys), and in the worst case scenario, foreclosures. Many of these will impact the borrower's credit (a foreclosure would stay for 7 years).

Right now, we have very high interest rates, that should generally push prices lower. However there is also a severe shortage of inventory, which is pushing prices up - these two factors are working counter to each other, thereby keeping prices somewhat steady. To solve affordable homeownership, cities need to approve more high density housing - but this is hard if you don't have roads, schools, public transportation and other infra/amenities. Absent that it will take a few years for rates to come down and supply to start going up - in the meantime, home ownership is at at healthy 65.6% (in line with historical mid-60's, other than some spikes leading up to the unsustainable sub-prime boom and during the historical low rates in 2020). So IMO, we need to wait for a mean reversion in rates, rather than reintroducing risky mortgage products that have a history of blowing up!