PRELIMINARY RESEARCH CIRCULATED FOR THE PURPOSES OF COMMENT AND FEEDBACK. PLEASE DO

NOT CITE WITHOUT THE AUTHORS’ PERMISSION.

Benchmarking a New Affordable Mortgage

Jaclene Begley Fannie Mae

Hamilton Fout

Fannie Mae & Kansas State University

Michael LaCour-Little Fannie Mae & California State University-Fullerton

Nuno Mota Fannie Mae

January 15, 2019

Abstract

Recently, Fannie Mae introduced a new low down payment mortgage product targeted to low- and

moderate-income households. We benchmark early loan performance to the performance of three

distinct control groups during the same time period using a multinomial logit framework. Preliminary

findings are positive, with generally lower odds of both delinquency and prepayment compared to other

low down payment products. Selection issues are also explored, contributing to the mortgage choice

literature.

Key words: affordable homeownership, mortgage, low-to-moderate income

Disclaimers and Acknowledgments

The views expressed are those of the authors and not those of Fannie Mae or the Federal Housing

Finance Agency. Any errors are ours alone.

20

1. Introduction

Access to credit is a key element in making homeownership possible for most households, and especially

lower income households and first-time homebuyers. Starting with the Federal Housing Enterprises

Financial Safety and Soundness Act of 1992, amended in the Housing and Economic Recovery Act of

2008, the government-sponsored enterprises (“GSEs”) operating in the secondary market are required

to meet goals with respect to acquisition of loans to very low-, low-, and-moderate income households.1

While supporting lending in this space is not a novel idea—the Federal Housing Administration (FHA),

the Department of Veterans Affairs (VA), and various local agencies, such as state Housing Finance

Agencies (HFAs), offer low down payment products; Fannie Mae recently developed a new mortgage

product with unique features to assist low down payment borrowers. Building on an earlier Fannie Mae

mortgage offering,2 the new HomeReady product allows for some additional attractive features for low-

to-moderate income borrowers who hope to purchase homes, and who rely on low down payments or

non-traditional sources of household income. These features are discussed in more detail below.

This paper introduces the new HomeReady product, and compares the prepayment and delinquency

performance of these mortgages with the performance of a sample of similar types of loans that are

often used by low- to moderate-income households and first-time homebuyers (e.g., FHA, HFA, and VA

loans). We compare performance for all four types of loans during the first 18 months of the

HomeReady program, which started at the end of 2015. Our preliminary results show that HomeReady

loans experience low 60-day delinquency and prepayment rates, and that this performance is generally

1 For more information, see: https://www.fhfa.gov/PolicyProgramsResearch/Programs/Pages/Duty-to-Serve.aspx 2 My Community Mortgage was Fannie Mae’s prior low down payment product, which allowed a 3% down payment for first time homebuyers.

2

similar to HFA loan performance. We also find that HomeReady loans are less likely to experience 60-

day delinquencies and prepayments during this time period when compared with FHA and VA loans.

The balance of the paper proceeds as follows: in the next section, we review the literature on barriers

to homeownership for LMI households, also considering various alternative mortgage contract designs

that have been proposed. Then, we describe the details of the HomeReady product and its evolution

since inception. In the fourth section we describe the three types of loans which we will use as control

groups and compare their features to the HomeReady model. The fifth section describes our data and

empirical methodology, and the sixth section reports results. The final section concludes with open

questions for further research.

2. Literature Review

The role of mortgage constraints in homeownership attainment for low- and moderate-income

households is a topic that has a long history. Early work on this topic by Zorn (1993) examined the

effect of constraints using survey data from 1986 and found them binding on 46% of households,

although effects were much greater on renters than on current homeowners. During the 1980s,

Linneman and Wachter (1989) find that wealth and income constraints both restrict homeownership

transitions, but note a stronger effect from wealth constraints. Engelhardt (1996) also finds evidence of

down payment requirements creating liquidity constraints for young households; and Herbert and Tsen

(2007) show that down payment assistance programs can be effective in helping households move past

wealth constraints to transition to homeownership. Similarly, Rosenthal (2002) estimated that

eliminating credit-underwriting constraints could potentially increase overall homeownership rates by 4

percentage points. Further disentangling the role of down payment constraints versus credit

requirements, Barkakova, Bostic, Calem and Wachter (2003) find that both are important barriers in the

3

1990s, with wealth constraints having the largest influence on homeownership transitions, although this

was diminishing with the rise of low down payment mortgage products, and credit constraints were

becoming more important during this same time period.

Examining the current time period, Acolin, Bricker, Calem, and Wachter (2017) estimate that recent

credit constraints (including wealth, income, and credit requirements) reduce homeownership rates by

about 2.3 percentage points when compared with the lending environment in 2001. However, Fout, Li,

Palim, and Pan (2018) find that using the current credit standards to underwrite borrowers from the

pre-crisis period would dramatically decrease default rates.

Focusing on the role of affordable lending programs, a number of papers examine the effect of specific

programs on housing outcomes and generally find positive outcomes. For example, Quercia, McCarthy,

and Wachter (2002) explore how different borrowing climates affect homeownership transitions using

the American Housing Survey and find that low down payment products have more success in

facilitating homeownership transitions for underserved populations when compared to products that

target income constraints. More recently, Stacy, Theodos and Bai (2018) and Freeman and Harden

(2014) both examine the role of specialized mortgage programs for low-income households on

mortgage performance and both studies either find no differences or positive results for their products.

This is in contrast with earlier evidence showing FHA mortgages with no owner-provided equity have

higher default rates (Kelly 2009). Moulton, Record, and Hembre (2018), comparing Housing Finance

Agency (HFA) affordable mortgages with conventional Fannie Mae mortgages, find that HFA borrowers

are much less likely to prepay or default than other borrowers. Finally, Lee and Tracy (2018) explore the

duration of homeownership and subsequent mortgage product use for FHA and VA borrowers in the

early 2000s, tracking them through 2016. They find that 55% of FHA borrowers, and a slightly smaller

4

share of VA borrowers, sustained homeownership during this time period and moved on to a non-FHA

or VA mortgage.

While we view affordable lending products as alternatives in our models, a number of studies explore

issues of selection bias across products, particularly focusing on the choice between conventional versus

government-insured mortgages. For example, Pennington-Cross and Nichols (2000) analyze selection

into FHA mortgages, and find that credit scores are a key determinant of selection into FHA, but other

features of that product, such as the insurance costs and down payment allowances, also play a role.

LaCour-Little (2007) shows that conventional programs compete with government-insured products,

and that borrower choice across mortgage products is rational, with borrowers choosing the lowest

priced alternative. More recently, Lang and Hurst (2013) examine borrower choice among households

receiving down payment assistance and also find that borrowers on the margin choose conventional

mortgages, rather than higher cost programs like FHA. Comparing default risk and selection into

conventional, privately-insured, and government-insured mortgages, Park (2016) finds evidence of

adverse selection into the privately-insured market, but not into FHA loans.

This paper contributes to the literature on affordable mortgage products by analyzing the prepayment

and delinquency performance of a new mortgage product designed to assist borrowers facing credit

constraints in the current lending environment. This product addresses two of the three credit

constraints identified in the literature: it allows for low down payment borrowers and potentially non-

traditional sources of income, but there are credit requirements for borrowers. Understanding the

performance of this product compared to other affordable products is important for better meeting the

needs of low-to-moderate income homebuyers.

5

3. The HomeReady Product

As part of its commitment to supporting housing affordability, Fannie Mae launched HomeReady, its

new affordable lending product targeted towards low- and moderate- income homebuyers in late 2015

(Fannie Mae 2016). HomeReady replaced My Community Mortgage, a similar earlier product that also

targeted low- and moderate- income homebuyers, but this version offers some notable enhancements

from the earlier program. The changes include: the removal of a first-time homebuyer restriction, an

allowance for a down payment as low as a 3% with mortgage insurance, and the removal of restrictions

on the source of down payment funds. Additionally, HomeReady offers a tiered mortgage insurance

structure for borrowers with between 80% and 97% LTV, and allows cancellable mortgage insurance

once the current loan-to-value (LTV) is reduced to 80%. HomeReady also has a homeowner education

requirement for most purchase loans that at least one borrower must fulfill.

A further new feature for HomeReady was the ability to consider non-borrower household income in

the mortgage application. HomeReady considers rental unit and boarder income as part of the borrower

application. It also allowed upfront debt-to-income (DTI) ratios of up to 0.50 with compensating factors

(such as non-traditional sources of income or attending one-on-one counseling), as Fannie Mae research

found that extended household income may help shield low-and moderate-income households from

unexpected shocks to household income, and therefore reduce their default risks (Scott 2015).3

Geographically, there are no restrictions on loan amounts other than the conforming loan limits, but the

household income is capped at 100% of the area median income (AMI) unless the property is in a low-

income census tract (Fannie Mae 2017).4

3 Fannie Mae eliminated the allowance for non-borrower income for this product in July 2017. 4 More information on HomeReady is available here:https://www.fanniemae.com/content/fact_sheet/homeready-overview.pdf; https://www.fanniemae.com/content/faq/homeready-faqs.pdf

6

Specific HomeReady Program Changes

A number of changes were made to the HomeReady product during its first two years. First, in June

2016, the additional delinquency counseling requirements for servicers of community lending

mortgages5 were eliminated. Then, in July 2016, the income restriction rules were modified to

standardize the geographic income limits to 100% of AMI, except in low-income census tracts where

there is no limit (before this date some areas had an income restriction of 80%). Additional rule changes

in July allowed potential owner-occupier borrowers to own other properties, additional counseling

requirements for limited cash-out refinances were removed, landlord educational requirements for 2-4

unit properties were removed, and additional homeownership counselors were approved for those

using the Community Seconds or the Down Payment Assistance Program with a HomeReady loan.6

Finally, in December 2016 a number of additional changes were made: maximum LTVs were increased

to 97% for 1-unit properties with limited cash-out refinances; increased eligibility for temporary

buydowns and adjustable-rate mortgages (ARMs) for 3-4 unit properties; and lenders with borrowers

who received HUD-approved counseling will receive a loan-level price adjustment (LLPA) credit of $500

and this counts as a compensating factor to increase upfront DTI up to 50% (Fannie Mae 2018a,b).7

Table 1 provides a summary of the key product information for the HomeReady product for loans on 1-

unit properties.

5 These are additional loans or grants provided by local housing agencies or employers that provide additional down payment assistance. 6 Community Seconds and the Down Payment Assistance Program are Fannie Mae programs that allow for different forms of borrower down payment assistance and may cover closing costs. 7 As of July 2017, Fannie Mae now allows a DTI of up to 50% on all loans, but the HomeReady loans in our sample had this policy in-place before the change was applied to all potential loans.

7

Table 1: HomeReady Product Characteristics

Loan Purpose Purchase or cash-out refinances

Loan Structure 10–30 year fixed-rate mortgages (FRMs); 5/1, 7/1 and 10/1 ARMs

Occupancy Principal residences, cooperatives, condominiums, manufactured housing, and planned unit developments (PUDs) allowed. Ownership of other properties allowed. Non-occupant borrowers allowed.

Borrower Income No income limit in low-income census tracts; 100% of AMI in all other tracts

Minimum Borrower Contribution $0 for most loans, but 3% when the borrower contributes sweat equity

Sources of funds Cash, gifts, grants, Community Seconds, sweat equity

Loan-to-Value Maximum LTV 97% for FRMs and 95% for ARMs; CLTV up to 105% with Community Seconds

Mortgage Insurance Tiered, cancellable mortgage insurance premium payments for borrower. Insurance provides standard coverage for LTVs between 80-90%; 25% coverage for LTVs above 90%.

Minimum Credit Score 620 or higher, with some exceptions for nontraditional credit profiles

Other Income Boarder income can count for up to 30% of qualifying income; rental income may be considered

Loan-Level Price Adjustment 0% for loans with LTVs > 80% and credit scores ≥ 680; 1.5% cap otherwise; $500 credit for participating in housing counseling

Source: Fannie Mae 2018c

4. Benchmarking Loan Performance to Control Groups

As HomeReady is meant specifically to offer benefits to households with lower incomes and low down

payments, we compare the performance of the first year of originations of HomeReady mortgages with

the performance of similar products for low- and moderate-income homebuyers. Specifically, we

8

examine the performance of the HomeReady product compared with the HFA, FHA, and VA loans during

the same time period.

Housing Finance Agencies

HFAs are state-chartered to help provide paths to affordable homeownership within their states (NCSHA

2017). HFA loans are often targeted to first-time homebuyers or borrowers with lower incomes, allow

low down payments, often are able to provide lower interest rates, and allow for flexible sources of

down payment funds. Additionally, many HFA programs have homeownership education requirements,

are typically conservatively underwritten to meet conforming loan standards, and are often then

securitized by GSEs who may have some recourse with the HFA agency. HFAs also benefit from an

exemption from the Qualified Residential Mortgage (QRM) requirements (Moulton, Record, and

Hembre 2017; NCSHA 2011).8 Given these parameters, HFA loans represent a natural benchmark

against which to measure HomeReady loan performance.

Federal Housing Administration-Insured Loans

FHA offers another product targeted to low-and moderate-income homebuyers. The FHA insures loans

with as low as 3.5% down payments. It also has less stringent credit score requirements than

HomeReady (the minimum for FHA loans is 500, with an LTV limit of 90%, and 580 for the maximum LTV

of 96.5%) (FHA 2017). However, FHA loans come with potentially higher costs for borrowers: all

mortgages have an upfront mortgage insurance premium payment of 1.75% of the base loan amount,

and then an annual mortgage insurance premium, which is cancellable after 11 years only if the

origination LTV is less than 90%. If the LTV is greater than 90% the mortgage insurance premium is in-

8 https://www.ncsha.org/blog/ncsha-supports-bond-exemption-risk-retention-rule

9

place for the entire life of the loan (FHA 2017). Therefore, these additional non-cancellable insurance

premiums potentially increase the costs to the borrower for the life of an FHA loan.

There are no income limits to the FHA program, but there are varying restrictions on borrowing amounts

by geography, governed by the Housing and Economic Reform Act of 2008 (FHA 2017; Goodman,

Seidman, and Zhu 2015), and the FHA program features ultimately result in a higher share of lower

income and lower credit score borrowers using this product. Despite this, prior research finds that there

is actually considerable overlap in FHA and conventional borrower credit scores, particularly for

borrowers with high LTVs (Pennington-Cross and Nichols 2000) and that while Veterans Administration

(VA) loans also tend to have higher credit scores and incomes, this gap has been decreasing since 2009

(Goodman, Seidman, and Zhu 2015). Additionally, Park (2016) finds that FHA loans actually perform

better than privately-insured mortgages and are no different than conventional loans when using

comparable samples of loans. Therefore, the low down payment feature makes FHA loans an attractive

product for some borrowers and a natural alternative to HomeReady.

VA Loans

Similar to FHA-insured mortgages, the Veterans Benefits Administration offers low (or no) down

payment mortgages to qualifying veterans and their spouses. There is no minimum credit score to

qualify for a mortgage, and VA mortgages offer additional attractive benefits for borrowers, such as

lower interest rates and no annual mortgage insurance premiums, although most borrowers are subject

to an upfront funding fee). Furthermore, VA borrowers are subject to a residual income test in addition

to upfront DTI guidelines, and VA maximum guaranty amounts are set at the county-level (VA 2017;

Goodman, Seidman, and Zhu 2015). These loans are often compared to the FHA product because of

their appeal to borrowers with low down payment savings and weaker credit histories, although

10

historically these mortgages have performed better than other similar types of mortgages, particularly

FHA loans, even when controlling for important factors like income and credit (Lambie-Hanson and

Spitzer 2014; Goodman, Seidman, and Zhu 2015). Their strong performance and low down payment

option makes them another good comparison group for HomeReady loans.

5. Data and Methodology

We obtain HomeReady and HFA loan origination and performance data from Fannie Mae. The

HomeReady data includes loans that were originated during our sample time period. The HFA sample

consists of HFA loans that Fannie Mae purchased during this same timeframe, restricted to the HFA-

preferred and HFA-preferred Risk Sharing products,9 which are the majority of the HFA Fannie Mae

loans.10 While there are some programmatic differences across HFAs, our sample of loans are subject to

some consistent Fannie Mae-specific requirements, such as a credit score minimum of 620 or higher, as

well down payments as low as 3% (Fannie Mae 2018d). The FHA and VA loan data come from the

public Ginnie Mae issuance data. Given the stricter credit score and DTI standards for the HomeReady

product, we restrict the combined final sample to loans with a FICO credit score of 620 or higher,11 the

upfront DTI is capped at 0.50, and the combined loan-to-values (CLTVs) are capped at the HomeReady

limit of 105%, we also restrict the loan size to the high-cost area loan limit for conforming loans in each

year.12 Similarly, since the majority of HFA loans are given to first-time homebuyers, and only a small

share of loans in our sample are refinances (8%), we also eliminate refinancing loans and include only

30-year fixed rate mortgages.

9 HFA-Preferred Risk Sharing mortgages have no mortgage insurance, but the HFA agrees to buy back the loan if it goes 120 days delinquent within the first six months. 10 We drop the HFA preferred local and the HFA non-bond standard programs, which comprise 5.5% of the total HFA loans, as well as loans that fall under both the HomeReady and HFA umbrellas. 11 When there are co-borrowers, our data provide the minimum FICO score for the applying household. 12 https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Announces-Increase-in-Maximum-Conforming-Loan-Limits-for-Fannie-Mae-and-Freddie-Mac-in-2017.aspx

11

Since HomeReady is a new product, we only have a brief window of performance data. Thus, for all four

loan products in our sample, we restrict the data to mortgages with first payment dates between March

2016 and June 2017, and we have performance data for mortgages from March 2016 through March

2018. We only have a small performance period for these loans, with a range of nine to 24 months of

loan activity in our models (2016–2018), so we estimate models of early delinquency, defined as 60 or

more days delinquent, as well as prepayment. Acknowledging that differences in loan age will influence

these two performance measures, our preferred model specification includes month of first payment

fixed effects that capture heterogeneity in loan age that may otherwise bias our results.

Summary statistics reflecting the mean of each variable for the full sample, broken out by mortgage-

type, are included in Table 2. There are some noticeable differences in mortgage performance and

mortgage and borrower characteristics across the groups, many of which are not unexpected given the

different product characteristics. For example, VA experience the highest shares of prepayment,

followed by FHA, which are most likely due to the low-documentation streamlined refinancing program

offered by the VA and the FHA (FHA 2017; VA 2017). We also see distinct third-party origination

patterns across loan products—HomeReady and VA loans have high shares of retail-originations, but

FHA, VA, and HomeReady all have around 10% of their loans originated through brokers. The majority of

HFA loans are correspondent-originated.

Finally, even with the CLTV, credit score and DTI sample restrictions we imposed, there are still some

differences in the distributions of these variables across products, as show in Figures 1, 2, and 3. As

expected, FHA loans are more skewed to borrowers with lower credit scores, whereas HomeReady, HFA,

and VA loans all have the majority of loans with credit scores above 740. Similarly, while the majority of

12

borrowers across all products fall into the 0.41-0.44 DTI category, FHA and VA loans have notably higher

shares of borrowers with DTIs of greater than 0.45. There are only a few HFA loans in that category due

to Fannie Mae’s restriction on DTI during this time period. Similarly, only 3.5% of the sample of

HomeReady borrowers fall into the higher than 0.44 DTI category, despite the fact that relaxing the DTI

constraint to 0.50 for borrowers with compensating factors was one of the unique features of the

HomeReady product at the time of our analysis. For CLTVs, the HFA and VA products have the largest

share of borrowers with high CLTVs, due to the VA no down payment allowance and the use of down

payment assistance in these programs. In contrast, HomeReady borrowers have the lowest CLTVs, with

only a small share of borrowers using down payment assistance, and FHA loans most often have CLTVs

right at 96.5%, which is the LTV limit for the FHA program.

13

Table 2: Average characteristics for the purchase-only loans in the final sample, by product-type.

HomeReady HFA FHA VA

Share ever 60 days delinquent 1.4% 1.9% 6.2% 3.2%

Share prepay 3.6% 4.9% 7.1% 12.1%

Interest rate 4.1% 4.35% 3.9% 3.69%

DTI ≤ 0.20 1.8% 1.6% 1.9% 3.4%

DTI 0.21–0.30 15.2% 15.1% 13.5% 17.4%

DTI 0.31–0.36 20.9% 22.3% 17.9% 19.8%

DTI 0.37–0.40 20.0% 21.6% 16.5% 17.0%

DTI 0.41–0.45 38.0% 39.1% 27.2% 23.1%

DTI 0.46–0.50 3.5% 0.0% 18.5% 15.1%

FICO 620–639 2.2% 1.0% 13.0% 9.6%

FICO 640–659 4.4% 6.4% 19.4% 11.5%

FICO 660–679 6.2% 9.7% 18.9% 11.5%

FICO 680–699 10.9% 14.2% 15.6% 11.5%

FICO 700–719 13.3% 16.1% 11.9% 10.7%

FICO 720–739 14.6% 15.5% 8.0% 9.2%

FICO 740+ 48.1% 37.2% 13.2% 36.2%

Broker-originated 11.9% 1.7% 11.6% 7.3%

Correspondent-originated 21.5% 96.9% 59.8% 46.5%

Retail-originated 66.6% 1.4% 28.6% 46.2%

Combined LTV ≤ 90% 26.0% 8.2% 5.9% 9.8%

Combined LTV >90–95% 21.8% 14.4% 6.3% 7.5%

Combined LTV >95–97% 48.1% 24.9% 79.2% 6.3%

Combined LTV >97–100% 1.8% 19.1% 7.5% 34.4%

Combine LTV >100–105% 2.4% 34.3% 1.0% 42.0%

First payment date Dec-2017 Nov-2017 Oct-2017 Oct-2017

Number of borrowers = 1 77.3% 70.9% 61.9% 53.1%

N 58,380 57,091 734,744 335,694

Note: Loan information is at origination, with the exception of prepay and 60 days delinquency.

Source: Author calculations using GNMA and Fannie Mae loan performance data.

14

Figure 1: FICO score distribution at origination

Figure 2: DTI distribution at origination

0%

10%

20%

30%

40%

50%

60%

FICO 620-639 FICO 640-659 FICO 660-679 FICO 680-699 FICO 700-719 FICO 720-739 FICO 740+

HomeReady HFA FHA VA

0%

5%

10%

15%

20%

25%

30%

35%

40%

DTI .11-.20 DTI .21-.30 DTI .31-.36 DTI .37-.40 DTI .41-.45 DTI .46-.50

HomeReady HFA FHA VA

15

Figure 3: Combined LTV at origination

Figure 4 shows the nonparametric Nelson-Aalen cumulative hazard curves for the first 24 months of

payments for each type of loan, with the first interval set at the first payment month for each loan and

the hazard rate representing the share of loans in each period that reach their first 60 day delinquency

as a share of the total number of loans in each period that have not yet reached a 60 day delinquency.

The patterns here are consistent with the summary statistics, but highlight the contrast in the share of

60-day delinquencies across product types as the life of the loan increases. These curves show that FHA

and VA loans have a much higher rate of delinquencies over time compared with HFA and HomeReady

loans, which experience very similar first-time delinquency patterns.

Figure 5 reflects the same information as Figure 4, except the variable of interest is now whether the

loan has prepaid. These patterns are also consistent with the summary statistics, but the contrasts

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Combined LTV ≤ 90% Combined LTV >90–95%

Combined LTV >95–97%

Combined LTV >97–100%

Combined LTV >100–105%

HomeReady HFA FHA VA

16

between the government-insured products and HFA and HomeReady is even more apparent. In this

figure it is clear that VA and FHA loans, and particularly VA loans, are more likely to prepay than

HomeReady or HFA loans. Prepayments for VA and FHA loans also spike after 9 months, which is

consistent with their streamlined refinancing program requirements.

Figure 4: Nelson-Aalen cumulative hazard for 60-day delinquencies

0%

2%

4%

6%

8%

10%

12%

14%

16%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Shar

e R

each

ing

60

Day

s D

elin

qu

ency

Months Since First Payment Date

HomeReady HFA FHA VA

17

Figure 5: Nelson-Aalen cumulative hazard for prepayment

6. Preliminary Results

Using the pooled data, we model the odds of a loan remaining current, experiencing prepayment, or

experiencing its first 60-day delinquency during this time period using a multinomial logit framework:

ln (𝑝𝑖𝑗

𝑝𝑖𝐽) = 𝛼𝑗 + 𝛽𝑗𝑋𝑖 + 𝜇𝑖 + 𝜋𝑖 + 𝜀

In our models we control for all the variables displayed in Table 2, which include: borrower-level

characteristics (DTI at origination, FICO scores, and the number of borrowers), as well as loan-level

characteristics (interest rate at origination, whether the loan was third-party originated, and the CLTV at

origination). Loans are removed from the sample after they reach 60 days delinquency (or prepay). As

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Shar

e R

each

ing

Pre

pay

men

t

Months Since First Payment Date

HomeReady HFA FHA VA

18

we only have 9 to 24 months of observations for each loan, all of these variables are measured at

origination. To capture geographic variation in housing and mortgage markets, we include state fixed

effects. Additionally, to incorporate changes in these four programs over time and for differences in the

duration of observations for each vintage, we include month of first payment date fixed effects in the

full model specification.

The odds ratios from the multinomial logit model are displayed in Table 3, with FHA loans (and not

prepaying or being 60 days delinquent) as the reference groups. The first two columns show the model

with the loan product flags and without any other covariates, and show that VA, HFA, and HomeReady

loans are less likely to experience a 60-day delinquency than FHA loans, with VA having the higher odds

ratios of reaching 60-day delinquency compared to HFA and HomeReady. These results are in harmony

with the uncontrolled trends shown in Figure 4. In contrast, VA loans have substantially higher odds

ratios for prepayment compared with FHA, whereas HomeReady and HFA have much lower odds. This is

consistent with the higher share of VA loans in the sample prepaying, as shown in Table 2, and with their

streamlined prepayment offering.

The second two columns show the results of the model with the additional controls displayed in Table 2,

but without controlling for state fixed effects or first payment dates, and the final set of columns

displays the full model results including the fixed effects. The main results are consistent across the

three models: HFA and HomeReady loans are noticeably less likely to prepay, and also less likely to

experiencing a 60-day delinquency, when compared to VA or FHA loans. HFA and HomeReady loans

have similar odds ratios across the models, but the inclusion of state and first payment date fixed effects

results in HomeReady having slightly higher odds ratios of reaching 60-day delinquency (0.50 versus

0.43) and slightly higher odds ratios of prepaying (0.38 versus 0.29) compared with HFA loans.

19

The coefficients on the covariates are consistent with expectations; for example, increases in interest

rates and higher DTIs are associated with higher propensities to prepay and fall delinquent. On the

other hand, higher CLTVs are associated with lower odds of prepayment but higher odds of delinquency,

and higher FICO scores have lower probabilities of delinquency. Finally, broker- and correspondent-

originated mortgages have higher odds of delinquency and prepayment than retail-originated loans; and

the odds of delinquency and prepayment are lower when there is more than one borrower on the loan.

Together, these findings show that HomeReady and HFA loans are relatively less likely to experience 60-

day delinquency and to prepay than both VA and FHA loans, even when controlling for important

predictors, such as DTI, FICO, interest rates, origination-channel, and CLTV.

20

Table 3: Model results: multinomial logit model, odds ratios displayed

Model 1 Model 2 Model 3

Prepay 60 days Prepay 60 days Prepay 60 days

VA 1.75*** 0.51*** 3.02*** 1.03 2.59*** .80***

HFA 0.65*** 0.29*** 0.39*** 0.56*** 0.29*** 0.43***

HomeReady 0.47*** 0.20*** 0.34*** 0.44*** 0.38*** 0.50***

Interest rate 3.75*** 1.56*** 4.64*** 1.87***

DTI 0.21–0.30 0.80*** 0.68*** 0.82*** 0.69***

DTI 0.31–0.36 0.90*** 0.85*** 0.89*** 0.85***

DTI 0.37–0.40 0.978 1.00 0.95*** 0.99

DTI 0.41–0.45 1.04** 1.14*** 0.97* 1.14***

DTI 0.46–0.50 1.20*** 1.30*** 1.17*** 1.27***

FICO 620–639 1.08*** 12.10*** 1.07*** 11.51***

FICO 640–659 1.00 9.14*** 0.98** 8.76***

FICO 660–679 1.04*** 5.90*** 0.99 5.71***

FICO 680–699 1.10*** 3.75*** 1.04*** 3.65***

FICO 700–719 1.15*** 2.47*** 1.09*** 2.41***

FICO 720–739 1.05*** 1.90*** 1.03* 1.88***

Combined LTV >90–95% 0.78*** 1.28*** 0.75*** 1.24***

Combined LTV >95–97% 0.72*** 1.56*** 0.61*** 1.45***

Combined LTV >97–100% 0.55*** 1.04* 0.74*** 1.56***

Combine LTV >100–105% 0.47*** 1.21*** 0.52*** 1.52***

Broker-originated 1.25*** 1.32*** 1.23*** 1.28***

Correspondent-originated 1.03*** 1.08*** 1.01*** 1.11**

Number of borrowers = 1 0.88*** 1.97*** 0.94*** 1.97***

First payment date fixed effects N N Y

State fixed effects N N Y

N 1,185,909 1,185,909 1,185,909

Note: The omitted categories are: DTI ≤ 0.20; FICO 740+; CLTV ≤ 90%; retail originated, and number of borrowers = 2+. ***ρ < 0.01, ** ρ < 0.05, * ρ < 0.10

21

7. Next Steps

Our early findings suggest that new, well-designed affordable-lending products can complement existing

affordable offerings and have positive outcomes for low-to-moderate income borrowers as well as

lenders. Moreover, these products have the potential to compete in the primary market. In the coming

months, we plan to do more work to improve upon this preliminary analysis. First, we plan on including

more information on mortgage insurance premiums for each product type to incorporate additional

potential costs to borrowers in the models. Second, we plan to include controls to capture down

payment assistance programs, which vary in use across product types and may have additional influence

on prepayment and default behavior. Third, we plan to look at specific subsamples of our data, as well as

specific geographies within our samples, to further explore disparities in outcomes. Fourth, we plan on

doing further analysis to better understand which specific aspects of the HomeReady mortgage lead to

improved borrower outcomes. Finally, we plan to explore the potential for selection bias across

borrower samples into these products using lender-specific data as well as loan application data available

internally at Fannie Mae.

22

References Barakova, I., Bostic R., Calem, P., and Wachter, S. (2003). Does Credit Quality Matter for Homeownership? Journal of Housing Economics 12: 318–336. Engelhardt, G. (1996). Consumption, Down Payments, and Liquidity Constraints. Journal of Money, Credit and Banking, 28(2), 255-271. Fannie Mae (2015). “HomeReady Mortgage Comparison with Fannie Mae Standard and MyCommunityMortgage® (MCM®).” Accessed on 12/11/2015 at https://www.fanniemae.com/singlefamily/homeready Fannie Mae (2016) “Annual Housing Activities Report and Annual Mortgage Report.” Fannie Mae (2017). “HomeReady Mortgage: Built for today’s home buyers.” Available at: https://www.fanniemae.com/singlefamily/homeready Fannie Mae (2018a). “HomeReady Mortgage Overview.” Available at: https://www.fanniemae.com/content/fact_sheet/homeready-overview.pdf Fannie Mae (2018b). “HomeReady Mortgage FAQs.” Available at: https://www.fanniemae.com/content/fact_sheet/homeready-faqs.pdf Fannie Mae (2018c). “HomeReady Mortgage Product Matrix.” Available at: https://www.fanniemae.com/content/fact_sheet/homeready-product-matrix.pdf Fannie Mae (2018d). “Why Choose HFA Preferred Mortgage?” Available at: https://www.fanniemae.com/content/fact_sheet/why-choose-hfa-preferred-mortgage.pdf Federal Housing Administration (2017). “FHA Frequently Asked Questions.” FHA Resource Center Bulletin Board. Available at: https://www.hud.gov/FHAFAQ Fout, H., Li G., Palim, M., and Pan, Y. (2018). “Credit Risk of Low-Income Mortgages.” Fannie Mae Working Paper Freeman, A., & Harden, J. J. (2015). Affordable homeownership: The incidence and effect of down payment assistance. Housing Policy Debate, 25(2), 308-319. Government Accountability Office (2015) “Contingent Workforce: Size, Characteristics, Earnings, and Benefits”. Available at http://www.gao.gov/assets/670/669766.pdf Goodman, L. S., Seidman, E., & Zhu, J. (2015). VA Loans Outperform FHA Loans-Why? And What Can We Learn?. The Journal of Fixed Income, 24(3), 39. Haurin, D. R., Hendershott, P. H., & Wachter, S. M. (1996). Wealth Accumulation and Housing Choices of Young Households: An Exploratory Investigation. Journal of Housing Research, 7(1), 33.

23

Hemmens, G.C.; Hoch, C. J. (1996). “Shared housing in low income households.” In G. C. Hemmens, C. J. Hoch and J. Carp, eds. Under one roof: Issues and innovations in shared housing. Albany, NY: State University of New York Press. Herbert, C. E., & Tsen, W. (2007). The potential of downpayment assistance for increasing homeownership among minority and low-income households. Cityscape, 153-183. Kelly, A. (2008). "Skin in the Game Zero Down payment Mortgage Default.” Journal of Housing Research, 17(2), 75-99. LaCour-Little, M. (2007). “The Home Purchase Mortgage Preferences of Low-and-Moderate Income Households”. Real Estate Economics 35(4):265-290. Lambie-Hanson, L. and Spitzer, K. (2014). “Access to Veterans’ Services and Participation in the VA Home Loan Program.” Working Paper. Lang, B. J., & Hurst, E. H. (2014). The effect of down payment assistance on mortgage choice. The Journal of Real Estate Finance and Economics, 49(3), 329-351. Lee, D. and Tracy, J. (2018). “Long-term Outcomes of FHA First-Time Homebuyers” Federal Reserve Bank of New York Working Paper. Linneman, P. and Wachter, S. (1989). The Impacts of Borrowing Constraints on Home Ownership. AREUEA Journal 17(4): 389–402. Moulton, S., Record, M., and Hembre, E. (2018). “State Housing Finance Agencies and Low Income Homeownership: A Comparative Analysis of Loan Performance” Fannie Mae Working Paper. Park, K. A. (2016). FHA loan performance and adverse selection in mortgage insurance. Journal of Housing Economics, 34, 82-97. Quercia, R. G., McCarthy, G. W., & Wachter, S. M. (2003). The impacts of affordable lending efforts on homeownership rates. Journal of Housing Economics, 12(1), 29-59. Pennington‐Cross, A., & Nichols, J. (2000). Credit history and the FHA–Conventional choice. Real Estate Economics, 28(2), 307-336. Scott, W. (2015). Mortgage Lending and Non-Borrower Household Income. Fannie Mae Working Paper, Dec 29, 2015. Available at: http://www.fanniemae.com/resources/file/research/datanotes/pdf/housing-insights-012516.pdf Stacy, C. P., Theodos, B., & Bai, B. (2018). How to prevent mortgage default without skin in the game: Evidence from an integrated homeownership support nonprofit. Journal of Housing Economics, 39(C), 17-24.

24

US Federal Housing Administration (2015). FHA Single Family Policy Handbook. Accessed on 12/10/2015 at http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/handbook_4000-1. VA (2017). “Purchase and Cash-Out Refinance Loans: Eligibility” Available at: https://www.benefits.va.gov/homeloans/purchaseco_eligibility.asp Zorn, P. 1993. The Impact of Mortgage Qualification Criteria on Households Housing Decisions: An Empirical Analysis Using Microeconomic Data. Journal of Housing Economics 3(1): 51–75.