Zero-down mortgages are making a comeback

By Matt Egan, CNN

(CNN) — Many Americans would love to buy a home, but they don’t have tens of thousands of dollars to cover a down payment.

That massive roadblock is being removed by a new zero-percent down mortgage program launched two weeks ago by one of the nation’s largest mortgage lenders.

However, the new program, offered by United Wholesale Mortgage, is making some experts nervous about how these loans could backfire on homeowners — especially if home prices stop going to the moon. And for some, it’s bringing back bad memories of the subprime mortgage meltdown that fueled the 2008 financial crisis.

UWM, led by Mat Ishbia, the billionaire owner of the Phoenix Suns NBA team, said homebuyers who qualify won’t need to put down an upfront down payment.

Instead, the program will allow buyers to pay for 97% of the home’s value with a first mortgage and then provide the remaining 3% (up to $15,000) in the form of a second mortgage.

That second mortgage won’t accrue interest, but it will need to be paid back — in full as a balloon payment — when the home is sold, the mortgage is paid off or if the owner refinances.

‘Demand has been huge’

These mortgages are only open to first-time homebuyers and those making no more than 80% of the area’s median income.

“The initial demand has been huge. We already have a couple of thousands of loans submitted,” Alex Elezaj, UWM’s chief strategy officer, told CNN.

UWM said that no other wholesale lender or non-bank mortgage company is offering such a program nationally. (UWM is a wholesale lender that connects homebuyers and realtors with mortgage brokers through its Mortgage Matchup platform. Earlier this month, Mortgage Matchup was named the first-ever mortgage partner of the NBA and WNBA.)

Yet some worry that this kind of mortgage could cause problems for homeowners down the line.

The central risk is that because they put down no down payment up front, homeowners will be starting with no equity.

That means they’d find themselves instantly underwater (owing more than the home is worth) if the red-hot housing market suddenly cools and home values go down.

“It could happen again”

That could be a problem if the homeowner needs to sell quickly, perhaps because they lose their job, face financial distress or need to relocate.

Suddenly, they’d be on the hook to pay back that second mortgage. And because they’re underwater, the home sale won’t generate enough cash to retire the debt.

“If the homeowner lacks the cash to make up the difference, then he or she will be in default on the second mortgage and at risk of foreclosure and damaged credit,” said Patricia McCoy, a professor at Boston College Law School.

That scenario is “exactly what happened during the subprime crisis, when millions of homeowners were underwater on their mortgage and went into default,” said McCoy, a former mortgage regulator at the Consumer Financial Protection Bureau (CFPB). “It happened before and it could happen again.”

The housing bubble that popped around 2006 was fueled in part by an explosion of lending to subprime borrowers. In the years leading up to the bubble, lenders came up with new products like adjustable rate mortgages and no down-payment loans that ended up blowing up when home prices eventually collapsed.

Locked into high rates?

To be sure, right now the housing market is on fire. Home prices are at record highs and demand is so strong that some homes are selling above asking price after all-cash bidding wars.

Still, another potential issue is that homeowners could find themselves locked into high-interest mortgage rates if the Federal Reserve starts cutting interest rates.

That’s because in order to refinance at a lower rate, the homeowner would need to fully pay off that second mortgage. And they may not have enough cash to do that.

They could also be stuck with higher rates because the lenders won’t let the borrower refinance if they haven’t built up enough equity in the home.

There are other options for zero-down mortgages. For instance, Bank of America launched a zero-down payment mortgage program in 2022 for first-time homebuyers in certain Black and Hispanic neighborhoods.

As Bankrate notes, there are also zero-down home loans backed by the US Department of Agriculture (USDA) in rural areas as well as loans for veterans and surviving spouses guaranteed by the US Department of Veterans Affairs (VA).

‘Read the fine print’

Anneliese Lederer, senior policy counsel at the Center for Responsible Lending, said it’s crucial for homeowners considering the UWM loan program to be educated about the terms and conditions.

“Using fun lines like ‘no-down payment’ sounds exciting and great. But you need to read the fine print,” Lederer said. “This could be a fantastic product to allow people who can afford the mortgage payment but don’t have the down payment to access homeownership. But the question is: How do you pay off that second mortgage? What is the plan? Right now there is no plan.”

Dennis Kelleher, CEO of Better Markets, a nonprofit that advocates for tougher financial regulation, told CNN he worries that a mortgage product like this will hurt some borrowers if the housing market stumbles.

“These mortgages are going to be ticking time bombs – just like subprime mortgages –unless home prices continue to increase very substantially,” Kelleher said. “This has the potential to turn the American dream of homeownership almost immediately into a nightmare.”

Kelleher noted that although home prices are rising sharply now, there is no guarantee that will continue.

Existing home prices jumped by another 6% last month year-over-year to $407,600 — the highest median price in April on record.

“We don’t know if we are in a bubble that is going to burst or if the trend lines are going to increase,” Kelleher said. “But pushing 100% mortgage products on low-income people when housing prices are at historic highs should cause everybody to be very concerned.”

Lessons of the subprime crisis

Jonathan Adams, an assistant professor at Saint Joseph’s University teaching real estate finance, said the UWM loan program has “all the features that made subprime bad.”

UWM pushed back on these concerns, noting that borrowers must still go through strict underwriting guidelines.

“People who make these claims are uneducated about the current state of the industry,” said Elezaj, the UWM executive. “In today’s environment, UWM is responsible for underwriting the loan, which gives us confidence that these are high quality loans.”

“This is a huge positive. It’s helping consumers and is a great win across the board,” Elezaj said. “Think about all the people who are renting and would love to buy a house, but they face this roadblock of coming up with $10,000 or $15,000 for a down payment. This eliminates that.”

It’s also worth noting that some experts say lending standards have been improved significantly since the 2008 financial crisis.

The days of NINJA loans (no-income, no job, no assets) and adjustable-rate mortgages are largely gone.

“We’re not going back to 2006 here,” said Greg McBride, chief financial analyst at Bankrate. “Lending standards are light years removed from pre-crisis when there oftentimes weren’t any standards at all.”

Yet Adams, a former Wall Street analyst, cautioned that someone who can’t make a down payment and makes less than 80% of the median income (those that qualify for this loan program) is likely to suffer more in an economy when home prices are falling.

“One of the lessons of the subprime crisis,” Adams said, “was that you are not doing any favors to borrowers by making it too easy to borrow.”

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