February 24, 2011 (Jeff Alan)

Federal Reserve Bank of Cleveland economist O. Emre Ergungor is advancing the theory that the government can increase long-term housing sustainability by implementing a homebuyer down payment assistance program as opposed to interest rate subsidies.

Ergungor is basing his theory on previous research that suggests that a 1 percent interest rate could create an additional 74,000 homebuyers. But, if a down payment assistance program were to be implemented where buyers would receive $3,200, homeownership could increase by as much as 541,000 new owners over a long time frame at a lower cost.

“To make this simple point, my study assumes that the additional down payment comes from the government,” he said in his economic commentary. “But a higher down payment does not have to be in ‘assistance’ form in its entirety. In fact, one potential policy goal in the future could be to facilitate a return to the old strategy of saving to become a homeowner.”

Research has shown that the greatest barrier to low and moderate income homeownership is a lack of down payment. History has shown that more people become homeowners when down payment restrictions are eased.

“Historically, assistance has taken the form of either interest rate or down payment subsidies, but recent research suggests that down-payment subsidies are much more effective,” Ergungor said. “They create successful homeowners, homeowners who keep their homes, at a lower cost.”

Although there are currently no new housing assistance programs being discussed, nor did the Federal Reserve Bank of Cleveland imply that Ergungor’s research would lead to any such program, Ergungor believes that even after accounting for the cost of the additional new homebuyers, the down payment program is still cheaper than interest rate subsidies and that hopefully many new ideas will likely burgeon out of the ongoing policy debate.

But to add to the debate, we’d like to point out that current history has shown that down payment subsidies, such as those that led to the current housing meltdown in the form of seller assistance with down payments, did not prove to be a very effective means of creating successful homeowners and that probably the best method of creating more homeowners would be to embrace policies that create more jobs. Also, in the past, the “old” strategy of saving to become a homeowner did prove to be rather successful.

Tags: down payment assistance, interest rate subsidies, homeownership, housing assistance