Down payment standards and loan performance: Evidence from the GSEs and FHA portfolios

Policy discussions are increasingly focused on a return to more conservative mortgage underwriting standards.  This study explores the relationship between down payment requirements and loan performance of GSE and FHA mortgages, controlling for borrower characteristics and housing market conditions.   Loan performance models are estimated based on cohorts of loans originated between 1996 and 2010.  Model parameters are then used to conduct policy simulations to estimate the marginal or incremental impacts of tightening down payment requirements on cumulative foreclosure rates.  The contribution of this paper is three-fold: (1) Default and prepayment equations are estimated using the entire universe of loans from the GSE and FHA study cohorts, which yields parameter estimates that are most precise and robust.  (2) The study covers broad segments of the mortgage market.  Analyses are conducted on highly disaggregated loan product types.  (3) The study sheds important light on the policy question regarding how down payment requirements should be set in conjunction with other underwriting guidelines such as borrower FICO credit scores, incomes, and debt-to-income ratio.  Specifically, we present policy simulation results that demonstrate the relationship between down payment standards and loan performance by borrower credit score category, income bracket, etc.  The information can be used by policy makers to help design overall underwriting guidelines, with a focus on originating “sustainable” mortgages.