In the wonderful world of mortgage underwriting, risk dictates everything.
The more risk you present to a lender, the harder it will be to get approved for a loan.
That amount of risk will also determine what interest rate you’ll receive on your mortgage, so it’s good to keep the risk to a minimum, if at all possible.
One thing underwriters are especially wary of is layered risk, which is best described as layers of risk stacked on top of one another.
So if you have a low credit score, you’re deemed riskier than the guy or gal with an excellent credit score. That’s pretty straightforward.
But if you also have very little to put down on your new home, you’re now showing signs of layered risk.
Sure, there might be a lender out there willing to give you such a mortgage, but you’ll be charged accordingly. And by that I mean you won’t receive the ultra low interest rate you saw on TV. And for good reason!
To compensate for all that risk, which is proven over time via default rate data, lenders need to collect more interest.
As I’ve mentioned before, this is kind of strange because the riskiest borrowers end up with the highest interest rates, which makes their monthly payments even higher and perhaps less manageable.
Little Down? You Might Be Stuck with a 30-Year Fixed Mortgage
- Because low-down payment mortgages are inherently risky
- And ARMs are also riskier than fixed mortgages
- Lenders are shying away from offering that combination
- Especially since they allow low credit scores to boot
If you’re a risky borrower, your borrowing options may be limited. In other words, you might only be able to take out a certain type of loan, such as a fixed-rate mortgage.
However, you can only get a fixed mortgage via the program because the government-sponsored enterprise (GSE) discovered that ARMs perform a lot more poorly relative to their fixed-rate cousins.
And an ARM combined with a down payment as low as three percent is clearly a matter of layered risk.
In the company’s August outlook, they noted that mortgages with down payments below five percent (95+ LTV) were 31% riskier than loans with 20% down (80% LTV).
While that’s not necessarily a great deal riskier, they also discovered that 3/1 hybrid ARMs were 35% riskier than 30-year fixed mortgages.
In order to control the risk that many critics of this program will likely point out, Freddie Mac has decided to limit the loan type to fixed mortgages only.
Doing so means low-down payment borrowers won’t have to contend with interest rate resets, which could increase their monthly payment in the future.
This should limit defaults while also expanding the credit box, thereby allowing a wider array of creditworthy borrowers into the housing market.