If you’re hoping to buy a house in the very near future but are finding it tough to save money for a down payment, help may be on the way. Last month, federal regulators took steps that may restore zero down payment mortgages. It’s thought that the cherished zero down payment mortgage is just what the doctor ordered to restore the still sputtering housing market to its full former glory.
The change was reported in the New York Times, in the article U.S. Regulators Approve Eased Mortgage Lending Rules. You can go ahead and read the full article if you like, but here is the paragraph that captured the basic idea of what’s taking place:
“On Tuesday, the regulators completed that overhaul, but they left out any requirement for borrowers to make a down payment. The new regulations aim to strengthen the vast market for bonds that are backed with mortgages and other loans. The market is not back on its feet, despite low interest rates. But the regulators said that the new rules could set the stage for more lending.”
To be fair, there’s some jargon in the article describing qualified mortgages and non-qualified mortgages, and hinting that one or the other will have zero down payment mortgages, and the other may not. But my experience from many years in the mortgage business, is that what applies to one loan type will eventually apply to them all – particularly if it results in the sale of more houses.
Is this a good thing? I think not. Recent history should make that pretty clear.
It’s Obvious That Nothing Was Learned From the Housing Meltdown
Just four or five years ago people were drowning in debt on their homes. A big part of the problem was no income verification loans, commonly referred to as liar loans. These are the type of loans where the borrower throws out an income number, and the lender accepts it without verifying the validity. It’s not a stretch to say that most of the people who used these loans didn’t have the income they were claiming.
There were also sub-prime loans, loans made to people who had credit that was not acceptable under traditional mortgage lending programs.
But the biggest culprit of all were zero down payment mortgages. These virtually guaranteed that when the above loan types went sour, that there would be no equity available to cushion the blow.
As soon as property values began to decline, people with zero down payment mortgages were already underwater. And once you are, it’s virtually impossible to sell the property or to get a refinance under more advantageous terms.
The government tried to deal with this by using a variety of gimmick-type refinances, but they helped precious few people. The problem with the newfangled refinances is that they did little more than provide the owner with a lower monthly payment (sometimes), but added any unpaid principal balance to the back-end of the loan.
So while the homeowners may have been better able to cope with the new payment, their equity situation became even worse. Instead of being $20,000 underwater on a mortgage, the homeowners might find themselves $40,000 underwater as a result of the new loan.
That didn’t help anyone – but it appears that the powers that be are now fully prepared to go back to that universe.
We’re Doomed to Repeat History
We keep hearing how the housing market is improving – dramatically in certain circumstances. But that begs the question, why do we need to go back to failed lending programs in order to stimulate the housing market if everything is already go great???
I would submit that the housing market isn’t nearly as strong as of the officials are saying. If it were, there’d be no need to bring zero down payment mortgages back from the dead.
I’m not alone in this position. According to the article linked at the beginning of this post, former chairwoman of the FDIC had this to say about the new regulations:
“This is unfortunate,” said Sheila C. Bair, former chairwoman of the Federal Deposit Insurance Corporation, another of the regulators that approved the so-called risk retention rules on Tuesday. “If the loan goes bad, you have much bigger losses with zero percent down than 20 percent down.”
So why do we need to go back to zero down payment mortgages? Having been in the business when such mortgages were virtually common (for the record, I originated only one such loan and vowed never do it again), the reasons are fairly obvious, though they are all the wrong reasons.
The powers that be in the real estate industry and in the economy view rising house prices as a positive. The only way to make that happen in earnest is by stoking the fires with mortgage giveaways. Zero down payment mortgages mean that John Q. Borrower no longer has to delay purchasing a home for the day when he has a large enough down payment. He can go out and buy one today.
But that’s borrowing future business into the present. It doesn’t really create new buyers. And when tomorrow comes, there will fewer borrowers available to keep the housing market afloat, because everyone who would have bought a house a few years from now will have already done so.
So where does this leave us, if this new regulation takes root and takes off the way the very same prescription did prior to the housing meltdown? Probably about where it left us in 2008, 2009, in the years after that. Or worse.
Your Risk Doesn’t Go Away Just Because Regulators Say It’s OK
The officialdom are always going to do with the officialdom will do, but that doesn’t make it right for the rest of us. Just because regulators say that’s okay to do zero down payment mortgages, doesn’t mean that you need to go out and do one.
You will get in trouble with such a mortgage, for all the same reasons why people got into trouble a few years ago. It doesn’t matter what other people are doing, or what the people who are deemed to know tell you is right – you must always look after your own interests, and do what is right for you.
The Better Way to Finance Your Next Home
Many people connected with the housing market believe that the 20% down payment requirement had a big hand in collapsing that market. That probably is true, but only because the market had gone insane with zero down payment mortgages. In truth, requiring that buyers make a 20% down payment on a house is simply prudent lending.
Feel free to disagree, but there are a few reasons why I’ve always believed that the down payment requirement is absolutely necessary:
- If you can’t save up money for a down payment on a house, what will you do when a house needs a new roof or a new furnace?
- A 20% down payment gives you solid equity in the home, just in case property values do fall – and we now know that that’s more than possible.
- The larger your equity position in the home is, the more options you will have to either refinance or to sell the property later on.
- It’s much easier to payoff a mortgage that’s equal to 80% of your property value, than it is one that is equal to 100% of the value.
And a point we should all be concerned with: Zero down payment mortgages – and other mortgage give away programs – juice demand for housing. That causes property values to accelerate, making housing even less affordable, and setting the stage for the next collapse in prices.
No one of sound mind should favor that type of outcome. So even though zero down payment mortgages seem poised to be making a comeback, choose to not participate.
Resist the insanity, and do the following instead:
- Buy beneath your means – which means buy a house that’s less than what you can afford.
- Make the largest down payment you can.
- Take the shortest loan term possible.
- Make sure the basic house payment is no more than 25% of your stable monthly income – less is even better, that way you’ll be prepared if your income should take a dive.
- What ever the term of the mortgage is, plan to pay it off early – you need to do that more than ever.
- Try to buy a house for less than the prevailing market value – that will give you even more equity.
- Make it your overriding goal to own your home free and clear as quickly as you can.
That’s actually all old-school advice. It’s putting yourself in position to always have the upper hand on your home ownership situation. And that’s exactly where you need to be, especially given the developments of the past few years.
What are your thoughts about zero down payment mortgages? Good? Bad? Budding disaster?