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90s in the Nineties.

90s in the Nineties

The 1980s brought a flurry of activity in the mortgage banking industry. Many aspects of the mortgage finance environment are still rapidly changing. Tucked away and sometimes overlooked amidst this changing environment are a multitude of opportunities for growth and profit. Among the most promising of these opportunities are low down payment, high-loan-to-value (LTV) loans.

Changing demographics across the country have prompted the mortgage banking industry to create products that meet its customers' new needs. When the first baby boomers began purchasing homes in the 1960s and 1970s, their goal was to build equity and pay off the house as quickly as possible.

In today's markets, the focus cannot be quite so narrow. In fact, paying off the mortgage quickly may not be the best choice for the homeowner or the most profitable option for the lender. Many customers are changing their lifestyles and want access to the equity they've built up since they took out their initial home loan 10,20, or even 30 years ago. First-time homebuyers will remain a good, strong market in the 1990s, but there are other potentially strong market segments that could be tapped for high LTV loans.

In the 1990s, market segmentation will help lenders analyze the needs of first-time homebuyers, move-up buyers and empty nesters. High-LTV loans are becoming a more attractive and more profitable option for these groups. Also, the additional servicing income from the high-LTV loans is good for the lender's bottom line.

The tax deductions are especially appealing for move-up buyers and empty nesters since Congress passed the tax laws removing other consumer interest deductions. Simply put, the new tax laws eliminate interest deductions for all debt after 1990 with one exception - the mortgage loan. Owning a home and purchasing it with a low down payment loan can maximize tax deductible interest, increase homebuyer savings and provide the best tax shelter for most Americans. The loans also can provide cash to help customers pay off outstanding consumer loans. It also makes a lot of sense to lend to borrowers with an established record of payments and a steady income.

For example, consider the Ryan family. Jim and Dinah Ryan need a larger home now that their family is growing. They have $25,000 in equity build-up from the home they are in and $5,000 in cash available for the down payment. The Ryans also owe $10,000 on their car.

By purchasing a $150,000 home with a low down payment loan, the Ryans can benefit from the interest deductions on their taxes and add money to their savings every month. While they could put down $30,000 (a 20 percent down payment) and keep the $10,000 car loan, they would be better served with a high-LTV loan. Instead, they can put down 10 percent of the purchase price of the house ($15,000), pay off their car debt ($10,000) plus have $5,000 in cash to invest elsewhere or leave in savings.

By using the low down payment loan, the Ryans maximize their tax deductible mortgage interest and eliminate their non-tax deductible consumer interest. Although they increase their monthly mortgage payments, they decrease their total monthly debt payments. The lender also benefits from safely increasing the origination fee and growing the servicing portfolio with no increase in work.

With a low down payment, the loan may be as much as 20 percent larger, which means the servicing revenues and origination fees increase accordingly. Also, the default risk is equal, if not better, because the borrower retains the cash reserves and will be more likely to maintain an established payment record. Private mortgage insurance also can help manage high-LTV risk.

These discretionary buyers often choose to put down a minimum down payment because it gives them more 100 percent tax deductible mortgage interest, especially in top tax brackets. Housing appreciation is forecast to be about 2 percent to 4 percent a year in the 1990s, and a larger down payment will not significantly increase the homeowner's return on their investment. With a low down payment, high LTV loan, the homeowner can use the extra cash for alternative investments with a higher return.

The lender also benefits because higher balance 90 percent and 95 percent LTVs add more dollars of assets and revenue than lower LTV loans, with no incremental increase in labor. Under today's fixed-cost origination structure, processing time on a 95 percent LTV loan is the same as processing time on an 80 percent LTV, but with one major difference - more fees are coming in. The higher loan values also increase the lender's asset base. This translates into more cash flow, more servicing to sell and faster, safer growth for the lending institution. The bottom line is this: when aimed at the correct borrower segment, high LTV lending can enhance the lender's financial position.

The first-time buyer niche

The 5 or 10 percent down mortgage also benefits families where just a few hundred dollars at closing will make the difference between becoming homeowners or remaining renters.

According to the 1988 Harvard University Joint Center for Housing Studies' report, State of the Nation's Housing, homeownership rates declined between 1974 and 1987 for only one income group - families earning less than $35,000 a year. Although these families make up almost 70 percent of the population, affordability is a major obstacle - only about half of them own homes. This is a large, underserved market.

However, demographic shifts that show fewer household formations will help ease the affordability crunch because there will be less upward pressure on housing prices. Wages will rise faster than home prices and more Americans will be able to buy homes for the first time. Other families will be able to move up to better housing, without significant "payment shock."

High-LTV loans also can help people with a steady income, but who lack a large amount of cash for an initial down payment. This market niche has relatively low risk over the long run, and lenders overlooking it may be missing a chance to improve their bottom line. There are not enough traditional first-time homebuyers to make up for low down payment loans that are not being made, and many families are being squeezed out of this market because of rapid appreciation and changing demographics in the last few years. Private mortgage insurance also improves the quality of these loans by minimizing the lender's risk while keeping the mortgage payments affordable for homeowners.

Consider a family making $40,000 a year with $6,000 in savings that wants to buy a $90,000 home. In order to put 20 percent down, they would have to save for an additional seven years at a 5 percent annual savings rate. During those seven years, they would lose $16,400 of tax savings and they would miss $13,800 in appreciation if the house appreciated at just 2 percent a year. While paying rent comparable to a mortgage payment, this family would lose a financial opportunity worth more than $30,200. Also, the lender would miss out on a higher origination fee and a larger servicing income.

As the number of first-time homebuyers begins to shrink, high LTV conventional loans are a real profit opportunity. In the immediate future, 90 percent and 95 percent LTV loans represent a significant opportunity for lenders to put more loans on their books, increase their servicing portfolios and help with the affordability problem. People build security and financial strength through homeownership and they become excellent prospects for other financial services. In addition, with mortgage insurance, these loans can be produced without having to hold a great deal of capital, and the lender gets the benefit of a third-party underwriter.

Consider a borrower who has just enough to make a 20 percent down payment. A 90 percent loan may actually be less risky than an 80 percent loan because there is less financial stress on the borrower. With the high-LTV, the family's cash reserves will not be completely depleted, and they will be more likely to keep the home they move into.

Used effectively, the conventional, high-LTV loan is an important competitive weapon that can be aimed at the large low-to moderate-income market and trade-up borrowers. Both of these large segments are then served with a product that allows them to manage their assets optimally.

For example, a family with parents who are over 55 and a child still finishing college could sell their empty nest, which has $50,000 equity built up. Instead of investing all of their equity in a new home, a low down payment, high-LTV loan would give them $40,000 for expenses for college for their child, plus enough cash for a $7,500,90 percent LTV down payment on a retirement home. They would likely have money left over to spend on decorating their new home as well.

Under this plan, the borrower receives the full benefit from the equity as well as a new home. The institution makes a profitable, low-risk loan, and increases its customer base for marketing other products.

Move-up buyers also may be interested in these loans. Instead of investing all of their capital gains in their next purchase, all they have to do to avoid tax on the gains is to buy a more expensive property. Furthermore, borrowers age 55 and older are exempt from the capital gains tax (up to a certain amount) and probably want to buy down. Some retirees will want to use the accumulated equity for their retirement fund - for leisure, travel, or to cover high-cost, health care needs.

Traditionally, retirees have been reluctant to cash out their equity because they wanted to leave something to their heirs. However, while inheritance is taxed, gifts, up to a limit, can be given tax-free. Children and grandchildren will benefit more from transfers of wealth while the benefactor is living.

So, the bottom line here is that lenders who analyze risk only in terms of LTV may ignore market opportunities. LTV risk can be properly managed and the risk can be decreased with the use of private mortgage insurance.

As lenders evaluate the last quarter of 1990 and project their market plan for the rest of the decade, they should broaden their horizons to include the high-LTV market. Important segments such as empty nesters and move-up buyers are, like first-time homebuyers, excellent targets for this niche, and lenders should consider how high-LTV lending can produce profitable opportunities in the 1990s.

Christina Carosella is senior vice president of marketing for GE Capital Mortgage Insurance Companies, Raleigh, North Carolina.
COPYRIGHT 1990 Mortgage Bankers Association of America
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Copyright 1990 Gale, Cengage Learning. All rights reserved.

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Title Annotation:future of low down payment mortgage loans
Author:Carosella, Christina
Publication:Mortgage Banking
Article Type:Cover Story
Date:Sep 1, 1990
Previous Article:Mortgage frustration: some tips to reduce the odds of your borrowers "losing it," because your back office is in disarray.
Next Article:Development niches in the Nineties.

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