How Important Is Down Payment in Determining Default?

Amid new regulations and increased focus on underwriting standards, the Federal Housing Finance Agency recently released a working paper on the impact of down payment amounts on loan performance at the GSEs and Federal Housing Administration (FHA).

Overall, the federal agency found a nonlinear relationship between loan-to-value (LTV) ratio and foreclosure rates.FHFA also determined that credit score plays an important role alongside LTV ratios in determining the likelihood of foreclosure.

LTV ratios hold a stronger relationship with foreclosure rates among FHA loans than GSE loans, according toFHFA. “The implication is that the same level of change in original LTV requirement would have a larger impact forFHA borrowers than for GSE borrowers,” the FHFA stated in its working paper.

Among loans with FICO scores of 620 and debt-to-income (DTI) ratios of 31 percent, the foreclosure rate for GSE

loans with 100 percent LTV is a little more than twice that of loans with 80 percent LTV.

For FHA loans with the same credit characteristics, the foreclosure rate is almost three times as much among loans with LTVs of 100 percent compared to loans with LTVs of 80 percent.

When observing various LTV ratios among different classes of FICO scores, FHFA found, “the LTV-foreclosure rate relationship is sensitive to FICO.”

For example, raising LTV from 80 percent to 90 percent on a loan for a borrower with a FICO score of 620 increased the likelihood of foreclosure by 4.46 percentage points.

Making the same change in LTV to a loan for a borrower with a FICO score of 700 increased the likelihood of foreclosure by half that—2.23 percentage points.

For FHA loans, which are more sensitive to changes in LTVratio, the relationship between LTV and foreclosure is most dramatic between LTVs of 90 and 95 percent. This trend carries across all FICO scores observed.

Once LTV rises above 95 percent, the foreclosure rate tends to correlate less with LTV ratio, according to FHFA.

Meanwhile, DTI ratio correlated strongly with foreclosure rate. “As expected, across all LTV levels, borrowers with a higher DTI had a higher foreclosure rate,” FHFA stated.

However, the “LTV-foreclosure rate relationship has a relatively modest sensitivity to the DTI level,” FHFAfound.

When comparing LTV rates among delinquency rates,FHFA found similar relationships to what it found among LTVs and foreclosures.

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