Why Low-Down-Payment Mortgages Could Be a Tough Sell

When Fifth Third Bancorp this summer began offering mortgages with 3% down, it joined a growing list of big banks that have made splashy commitments this year to expanding access to homeownership.

Through a partnership with Freddie Mac, the Cincinnati bank is offering so-called "Home Possible" loans to borrowers in underserved neighborhoods. It has also sweetened the deal, offering up to $3,600 in down-payment assistance — a feature not offered by its larger peers.

But applicants are not exactly lining up at the door — at least not yet. Fifth Third has received about 70 applications since July, though it has a goal of collecting 850 by the end of the year. The bank says it is confident it will meet its target as marketing efforts continue to ramp up.

The slow start at Fifth Third illustrates some of the logistical challenges with low-down-payment programs, which are on the rise across the industry. After years of facing tight credit standards, many prospective borrowers are simply unaware that they can get a mortgage with so little skin in the game. And, following the housing crash, many are wary of doing so, observers said.

Offering low-down-payment loans simply requires extensive community outreach.

"There's a lot of grass-roots effort to make sure we have a lot of community involvement," said Ed Robinson, head of Fifth Third Mortgage. He added while the number of loans funded so far is "very small in number," the demand in the marketplace is high.

To attract interested buyers in two of its largest markets, Fifth Third has partnered with a Spanish-language website in Florida and a black-owned newspaper in Michigan. It has also spent time reaching out to nonprofits and real estate agents in low-income neighborhoods.

After years of essentially being shut of the mortgage market, prospective borrowers with low incomes or blemished credit histories are reluctant to move back in, according to Michael Calhoun, president of the Center for Responsible Lending.

"It's widely viewed out there that you need a 10% or 20% down payment to get a home loan, and there has been all of this publicity in the market about how credit is tightening," Calhoun said, pointing to recent survey data. "For the average person on the street, there's no reason to come in."

Calhoun noted that there is a pressing demand in the market for more affordable mortgages as many low-income individuals and families face soaring rents in major cities.

But getting the low-down-payment mortgage programs off the ground may take time. Banks are in the process of "relearning" how to lend to underserved borrowers in a "safe, sustainable" way, without teaser rates or thin documentation, Calhoun said.

Over the past year, several big banks have begun offering the mortgages with 3% down in conjunction with Fannie Mae and Freddie Mac.

Bank of America and Wells Fargo announced low-down-payment loans earlier this year through partnerships with Self-Help Credit Union, an affiliate of the Center for Responsible Lending. B of A, for instance, sells the loans and servicing rights under its "Affordable Loan Solution" program to Self-Help.

Fifth Third, on the other hand, sells its loans to Freddie Mac but retains the servicing rights.

The products offer an alternative to loans insured by the Federal Housing Administration. Banks have been scaling back on such loans — which include down payments of as low as 3.5% — after years of litigation with the agency over crisis-era underwriting.

"In some sense, we're shifting from one program to another," John Shrewsberry, chief financial officer at Wells Fargo, said during a quarterly earnings call in July.

Still, it is unclear whether banks have so far tapped into a large pool of interested borrowers.

On the call Shrewsberry did not offer details about how the so-called "yourFirst Mortgage" program has affected origination volume. Asked about demand to date for the 3%-down loans, a spokeswoman for Wells said the bank is encouraged by a "continued application trend."

Bank of America also declined to provide details on the demand for its 3%-down loans. "Our volume is very much as expected," a spokesman said.

Most of the loan programs across the industry are geared toward first-time homebuyers in underserved neighborhoods. At Fifth Third, for instance, borrowers must have a minimum credit score of 620 and an annual income that is below the median for the local area.

Applicants can also qualify by buying a home in census tracts designated as low-income, according to the company.

Fifth Third has an additional incentive to boost applications for its so-called "Home Possible" program: The bank receives credit under the Community Reinvestment Act by offering the loans.

Notably, Fifth Third received a downgrade in its CRA score in July — a designation that prevents it from doing bank M&A deals. The bank expects its next evaluation to take place later this year.

As part of its $27.5 billion community development initiative announced in February, Fifth Third set aside $10 billion to provide the down-payment assistance of up to $3,600 for qualifying borrowers.

The $10 billion in down-payment assistance is just a "starting place," and the bank will evaluate whether to provide additional assistance in the future, Robinson said. He also noted that the bank does not raise the interest rates on the loans to make them more profitable.

As Fifth Third continues to reach out to community groups in its local markets, it feels confident that will generate interest in the program in the coming year.

"Operating nationally but thinking locally is how we operate," Robinson said. "I think we have a moral obligation to put our best foot forward."