Downpayments are required again thanks to the credit crunch. Many people thought 100% financing would be made available forever. They were mistaken. One-hundred percent financing will never return because it exposes lenders to too much risk.
Most people do not think of downpayments as a way of managing risk, but lenders do. Downpayments reduce risk in two ways: first, they lower the monthly payment, and second, they provide a cushion ensuring the borrower can refinance (if necessary) should the house value decline. The problem with downpayments is obvious: few people save enough money to have one.
Eliminating downpayments through the use of 80/20 combo loans was another massive stimulus to the housing market. Subprime loan originations in 2006 had an average loan-to-value ratio of 94%. That is an average downpayment of just 6%. Also, 46% of home purchases in 2006 had combined loan-to-value ratios of 95% or higher.
Lenders used to require downpayments because they demonstrated the borrower’s ability to save. At one time, having the financial discipline to be able to save for a downpayment was considered a reliable indicator as to a borrower’s ability to make timely mortgage payments. Once downpayments became optional, a whole group of potential buyers who used to be excluded from the market suddenly had access to money to buy homes. Home ownership rates increased about 5% nationally due in part to the elimination of the downpayment barrier and the expansion of subprime lending.
Besides stopping people from saving for downpayments, 100% financing harmed the market by depleting the buyer pool. In a normal real estate market, first-time buyers are saving their money waiting until they can make their first purchase. This usually results in a steady stream of first-time buyers that enter the market each year. When 100% financing eliminated the downpayment requirement, it also eliminated any need to wait. Those who ordinarily would have bought 2-5 years in the future were able to buy immediately. This emptied the queue.
This type of financing appears periodically in the auto industry, especially in downturns when it is necessary to liquidate inventory. The term for this is “pulling demand forward,” because it reduces demand for new cars in the next few years. This might not have been a problem if 100% financing would have been made available to everyone forever; however, once downpayment requirements came back those who would have been saving were already homeowners, so there were few new buyers available, and any potential new buyers had to start over saving for the downpayment they thought would never be required.
The situation was made worse because those late buyers who were “pulled forward” from the future buyer pool overpaid, and many lost their homes. This eliminated them from the buyer pool for several years due to poor credit and newly tightened credit underwriting standards. Thus, most who thought 100% financing was a dream come true found it to be a nightmare instead.
Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: http://www.thegreathousingbubble.com/
Read the author’s daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/
[tags]housing, real estate, buying real estate, housing bubble, real estate bubble, house for sale[/tags]
|
|