This week Bank of America launched its Affordable Loan Solution program, which offers mortgages requiring as little as 3% down and a minimum FICO score of 660 to customers who cannot afford more substantial front-end costs.
The program is a partnership with Self-Help Ventures Fund in Durham, N.C., part of Self-Help Credit Union, a community development credit union. Self-Help will buy both the loans and servicing rights and provide post-closing financial counseling, and Freddie Mac, which will purchase all eligible mortgages.
Because Self-Help is taking the first-loss position, borrowers are not required to purchase mortgage insurance.
“It’s an innovative partnership between Bank of America, Self-Help, and Freddie Mac that provides an alternative product for low- to middle-income homebuyers who are qualified but don’t have the resources to make traditional down payments,” explained Terry Francisco, senior vice-president at Bank of America. “A down payment as low as 3% without the need to pay mortgage insurance makes it a less-expensive loan than going through the FHA.”
To a lender, this program is arguably less risky than similar products offered by FHA requiring a 3.5% down payment or a minimum FICO score of 520—requirements that critics say look very much like sub-prime lending.
The Affordable Loan Solution “absolutely is not sub-prime lending,” Francisco says. “It goes to buyers who are otherwise very qualified. We're just giving them help on the front end so they can afford the down payment.”
Moreover, as he points out, credit scores are more predictive of foreclosure than the size of the down payment.
“We’re hoping, given the low-interest rate environment, people already in a position to buy will find this the extra bit of help they need to get into the mortgage.”
Freddie Mac spokesman Brad German stressed the program’s soundness and the steps taken to minimize risk.
“One hundred percent of the loans in this initiative will be reviewed by our quality control staff when they are delivered,” German says. “This will help ensure the loans are of high quality, meet our requirements, and help us manage risk. They reflect prudent, sound underwriting, designed to make responsible homeownership opportunities available to qualified borrowers.”
Partnerships: future of lending
Another aspect designed to minimize risk is the partnership among the three entities.
“We came to an agreement with Freddie Mac and Self-Help to be in a recourse position so if something should happen to the loan, Self-Help will take responsibility,” B of A’s Francisco says.
In today’s post-crisis environment, he predicts partnerships such as this one will become more common because they provide collective skills to counter specific risks.
“Self-Help provides expertise in counseling so if someone has an income interruption later on or another issue that affects their ability to repay, Self-Help has the expertise to help them avoid default,” Francisco says.
Michael Fratantoni, chief economist at the Mortgage Bankers Association, says the form of financial counseling that's been found to be most effective is what takes place if a homebuyer gets into trouble. “Particularly now, when there are a lot of loss-modification programs out there, counseling can be extraordinarily effective,” he says.
Partnerships among large banks, community groups, and investors not only can allow lower- to moderate-income borrowers to access credit with less risk; they also help fulfill the goal Fannie Mae and Freddie Mac have of trying to reduce taxpayer exposure by dispersing more risk into the marketplace.
“The industry has talked about two ways to do this.” Fratantoni says. “One is back-end risk sharing, where Fannie and Freddie acquire risk, then use a capital market instrument to lay off some of that risk on investors. The other thought is to do more front-end risk sharing, where the partner of the lender takes some of that risk before it goes to Freddie.”
In the Affordable Home Solutions program, Self-Help assumes that risk, effectively stepping into the shoes of taxpayers. “Certainly, ideas to have lenders or partners take on risk on the front end makes a lot of sense,” Fratantoni says.
The new program will be arranged through all B of A mortgage sales channels, both in-person and over the phone, and online.
Program features not seen as risky
FHA's history of offering mortgages for 3.5% down has shown that the performance of those loans is very similar to those acquired with a 5% down payment.
“It’s essentially the same profile borrowers—first-time homebuyers who would have a substantial amount of trouble saving for a 20% down payment,” Fratantoni says. “By going to 3% instead of 5%, they can get into the home earlier and start building equity.”
And while a 660 FICO rating is not a sterling credit score, Fratantoni says it is not unacceptable risk.
“If you go back to credit scores pre-crisis, it was not unusual to have borrowers in the 650-700 range,” Fratantoni says. “That's someone who is regularly paying their bills, but might have had a problem a couple of years ago—a stumble, but not a major derogatory event. By no means is it taking on too much risk.”
Indeed, the view of other economists is that lending standards may be overstated as the root of the recent crisis, after all.
“I don’t think we will experience another sub-prime crisis,” says Stephen Matteo Miller, PhD., a senior research fellow in financial crisis at George Mason University's Mercatus Center. “My view is that the demand for structured finance [collateralized debt obligations] drove the residential mortgage-backed securities market leading up to the last crisis, and not the other way around. “
Elaborating, Miller says that the demand for those CDO tranches “gave lenders every reason to find ways to lower lending standards to keep feeding the securitization chain.”
Miller indicates that there was a multiplier effect at work as a result.
“One reason banks and insurance companies increased their demand for those CDOs was regulatory arbitrage,” Miller says. “So tighter mortgage standards might have reduced the number of structured finance CDOs originated prior to the crisis, but the losses throughout the financial system arose because small increases in mortgage defaults created spectacular CDO losses.”
Thus, the problem arose in the securitization arena, according to this line of thinking, rather than in mortgage lending per se.
Miller believes that the subprime crisis demonstrated that using even supposedly stable housing debt as collateral “couldn't prevent structured finance CDOs from crashing— spectacularly.”