A Cautionary Tale of How the Presence and Type of Down Payment Assistance Affects the Performance of Affordable Mortgage Loans

Despite technological advances, buying and financing a home remains a complicated process fraught with unknowns and uncertainties. This is especially true for inexperienced low- and moderate-income (LMI) renters. For example, a recent Fannie Mae ethnographic study of LMI aspiring homebuyers found that unstable income and insufficient credit history are among the barriers to a successful search.

Saving for a down payment remains one of the biggest barriers to obtaining a home mortgage (Gudell 2017). Although most research finds that higher leverage increases default risk, the post-financial crisis share of conventional 30-year purchase loans requiring 10% down or less rose from 5% in 2010 to 35% in 2018 (Barrett and Maloney 2018). What is most striking about this return to high-leverage home lending is the proliferation of both privately sponsored and government-funded down payment assistance (DPA) programs across the country. There are now more than 2,000 such programs, and these have the collective effect of reducing first-time home buyers’ contributions from as little as 3% to something substantially less.

In the view of one group of researchers, this shift is “possibly fundamentally changing the economics of low-down-payment lending” (Goodman, et al. 2017). The role of leverage in loan performance has a long and distinguished research record, which will not be repeated here (Deng, et al. 1996; Theodos, Stacy, and Monson 2015; LaCour-Little, 2008). One question that has yet to be answered is whether the addition and form of DPA in conjunction with low-down payment purchase loans has an independent effect on default risk. That is the focus of this article.