Literature Review: The Credit-Enhancing Functions of Downpayment and Downpayment Substitutes
In this study a literature review was contracted to examine the various credit enhancing roles of down payment and the respective qualitative and quantitative importance of mortgage down payments of varying sizes. Through review of the literature, the study identified multiple functions of the mortgage down payment and potential down payment substitutes. The functions of the mortgage down payment identified include the capacity and willingness to repay, capacity and willingness to maintain the property and pay for unexpected repairs, commitment to home ownership, “skin in the game”, and protecting lenders against the probability of default, loss severity, and market risk. The study identified eleven potential substitutes for the down payment which include borrower credit history, counseling, individual development accounts (IDAs), community land trusts (CLTs), borrower reserves, borrower income and residual income, short-term mortgage products, shared appreciation mortgages (SAMs), mortgage insurance, home price index futures, and home equity insurance. Although many alternatives to cash down payment exist, the study found no substitutes to perfectly replicate all its credit enhancing functions. Instead the authors suggest using multiple complementary substitutes to achieve the desired level of credit enhancement.