1% Mortgages are here (Subprime Crisis 2.0?)

1% Mortgages are here (Subprime Crisis 2.0?)

Some interesting news hit the Housing Market last week. Rocket Mortgage and United Wholesale, America's two largest mortgage originators, unveiled that they are now offering 1% downpayment mortgages to qualifying borrowers.

These mortgage products seek to make it easier for low-income Americans to buy a house in 2023 by offering them free money. A scary development given that America is only 15 years removed from the last Subprime Crisis. When free money and loose lending led to a cataclysmic collapse of the housing market and economy.

As a result: could this be a sign that America is heading for Subprime Crisis 2.0?

Let's find out. In this post I will break down the data behind the new 1% mortgage program and how it will impact the housing market.

1% Mortgages = Greater risk of Default

This 1% mortgage program allows low-income homebuyers to purchase a house with as little as 1% down.

Meaning that if someone in Atlanta were to buy a house for $300,000 using this program, they would only need to put $3,000 down at closing. The remaining $297,000 is covered by the lender.

Such a low downpayment greatly increases the risk of homeowner default and foreclosure into the future because 1) the homeowner has less skin in the game and 2) it's more likely they end up underwater if the local market crashes.

Historical research from the FHA proves this out. With the graph below showing mortgage default probability across the loan-to-value ratio spectrum. You can clearly see that the higher the closing LTV (aka the lower the downpayment), the greater the risk of mortgage default.

The default rate on mortgage increases substantially with lower downpayments.
The default rate on 1% down is nearly 4x higher than 30% down. (Source: FHA)

The anticipated default rate on 1% downpayment mortgages is about 4%. Which is 4x higher than the default rate on mortgages where the buyer puts 30% down. Also note that the default rate nearly doubles going from 15% down to 1% down.  

Indicating that Rocket Mortgage and United Wholesale are taking some big risks with this loan program. They could have quite a few delinquent borrowers on their hands, especially if home values continue to decline.

Mortgage lenders okay with giving out "Free Money"

But these lenders seem okay with the increased risk of default under this loan program. Because in the near-term, their bigger concern is increasing their loan origination volumes. Which are pitifully low right now.

According to new data from ATTOM Data Solutions, home mortgage lending just fell to a 20-year low in Q1 2023. Meaning that the mortgage lenders are not making very much money currently since their main source of income is fees generated from issuing new loans.

Meaning that these lenders are having to get creative to entice homebuyers back into the market. Which is where this 1% mortgage program comes in. According to Rocket Mortgage's executive vice president, their new ONE+ program amounts to giving homebuyers free money.

“With affordability being tougher, people are getting boxed out,” says Bill Banfield, executive vice president of Capital Markets at Rocket Mortgage. “Free money helps people want to buy a home.”

That quote sounds like something straight out of 2004 or 2005. Which is scary. Because it suggests that mortgage lenders are starting to forget the lessons learned two decades ago. And getting looser in their lending standards.

The Good News: Homebuyers aren't taking the bait...yet

The good news thus far is that homebuyers aren't taking the bait so far. With mortgage applications to buy a house hitting the lowest levels in 28 years to close out May 2023.

The most recent mortgage purchase index printed from the Mortgage Bankers Association showed a level of 154. Which is:

  • 30% below last year
  • 56% below 2021 peak
  • 70% below 2005 peak

Indicating that homebuyers are much smarter today than they have been in the past. They know that today's sky-high combination of prices and mortgage rates make it a bad time to buy. And thus, they're boycotting the housing market.

Which is ultimately why these mortgage lenders are getting so desperate.

However, I wouldn't be surprised if we see an increase in mortgage applications in coming months as the lenders get more aggressive advertising these new products. Particularly among low-income households with lower credit scores.

1% mortgage targets low-income Homebuyers

Because here's the catch: these 1% mortgage programs are only available to low-income homebuyers who make less than 80% of an area's median income. Meaning that if your area's median income is $80,000, only households who make $64,000 or less would be eligible.

The reason for the income-requirement is because these mortgages are offered through Fannie Mae's HomeReady Mortgage platform. Which is a US government-sponsored program that allows low-income buyers to purchase houses with as little as 3% down.

Rocket Mortgage and United Wholesale now cover 2% of that downpayment. Leaving the homebuyer only needing to cover 1%.

Rocket Mortgage is also waiving mortgage insurance premium (MIP) costs for homebuyers in their ONE+ program. Which is actually a much bigger deal than the 2% downpayment grant. Because it would save low-income homebuyers anywhere from $100-250/month on their ongoing monthly payment.

The whole point of mortgage insurance is to provide the mortgage lender with an additional capital buffer to compensate for the higher likelihood of default on a low downpayment mortgage.

But now Rocket Mortgage and United Wholesale are doing away with that. And treating the risk profile of a 1% downpayment borrower as similar to a 20% downpayment borrower.

Which is a bit of a gut punch to moderate to high-income households who have been diligently saving for that 20%+ downpayment. They're being responsible and doing what they should be doing. And getting no reward for it. In fact, they're getting penalized, with the FHFA announcing last month that they will increase fees for high-credit score borrowers so they can reduce fees for low-credit score borrowers.

Stuff as many low-income buyers into the market as possible

Reading between the tea leaves: it looks like mortgage lenders and the US government are teaming up to try and stuff as many low-income borrowers into the housing market as possible. They do this under the auspices of "expanding homeownership access to all" and helping low-income buyers "overcome affordability constraints".

But what they're really doing is baiting low-income households into taking on excessive amounts of mortgage debt in the early stages of a housing downturn and recession.

The mortgage lenders are doing this so they can earn fees. The US government is doing it so they can provide life support to the housing market before the 2024 election.

Fortunately, lower-income households aren't taking the bait with near record high 77% of Americans thinking it's a bad time to buy a house. And mortgage applications hitting 28-year lows as a result.

Indicating that we are not yet approaching a Subprime Crisis 2.0 scenario. However, that could change in the future, especially if mortgage lenders and the US government continue to get more aggressive in pushing risky mortgages on low-income homebuyers.

We'll need to watch the mortgage application data closely to see if there's an increase in coming months.

What are your thoughts on the 1% downpayment mortgage program?

What do you think about this 1% mortgage program? Do you think we'll enter another mid-2000s period of loose lending and bad mortgage origination?

Let me know in the comments below. Would be great to hear from those that work in the mortgage industry especially. Are you seeing demand for these loans?