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March 6, 2000
"Is the ability of
people to borrow without a down payment a strength of the US mortgage
system, or a weakness?"
Both. Some
families become successful home owners with the help of 100% loans.
Others, who shouldn't be home owners, are enticed to try 100% loans and
they fail. They bear more of the costs of their failure than the lenders,
and sometimes their communities suffer as well.
100% loans have high default
rates. This has been a finding of every study of mortgage defaults that I
have ever seen.
One reason is that home-owners who
borrow the full value of their property have less to protect should
economic adversity strike. If they lose their job, or if property values
decline temporarily, they lose less from a default than borrowers with
equity.
In addition, borrowers able to
accumulate a down payment demonstrate budgetary discipline and the ability
to plan ahead. People able to save money every month before they buy a
home, are much more likely to meet their monthly mortgage obligations
afterwards.
Why do lenders make 100% loans?
When property values are rising, as they have been in recent years, the
impetus for default is weakened. Rising values create equity in houses
that were initially mortgaged to the hilt.
In recent years, lenders have also
become more confident in their ability to assess the willingness and
capacity of borrowers to repay their mortgages. Using credit scoring and
other tools, they judge that it is safe to give less weight to an
applicant's ability to accumulate a down payment.
Lenders protect themselves,
furthermore, by charging higher rates on 100% loans. The rate includes a
"risk premium" to cover the losses lenders expect from the
higher delinquencies and defaults on 100% loans.
Just because a lender is willing
to give you a 100-percent loan, however, doesn't mean you should take it.
The risk premiums protect lenders, not you.
Should you default your costs
include not only loss of your house, but the costs of having to find
another one and all the disruptions to your life that that typically
involves. Plus your credit rating goes into the tank. And if many
defaulters live in the same neighborhood, the neighborhood can also tank.
Some people are not cut out to be
home-owners. If you could have written either letter below, you are one of
them.
"I hadn't been in my house 3
weeks when the hot water heater stopped working. Only then did I realize
that I hadn't been given the name of the superintendent�who do I see to
get it fixed?"
Responsibility is central to
ownership, but people who have learned to depend on others often find it a
difficult concept to grasp.
"�the man [who came to my
door] said my roof would fall in if it wasn't replaced�it wouldn't cost
me any money for 3 months, and then just $250 a month�and now they tell
me I have to pay them $4500 or they'll take my house�I did sign a lot of
complicated papers that I know I shouldn't have�."
This home-owner has several
characteristics, any one of which can cause trouble for a home owner; in
combination, they will spell disaster every time. Among them:
*Deciding on repairs and
improvements based on a solicitation by a huckster.
*Failing to seek out competitive
bids.
*Assessing the cost based on the
monthly payment, ignoring the interest rate and fees included in the
loan amount.
*Signing documents that aren't
clearly understood.
I have received letters from many
home owners who should have remained renters until they passed Home
Ownership-101. Yet there are many other households who could pass the
course, and who could accumulate the funds for a down payment in a few
years, but they don't have the funds now. Their problem is whether or not
to wait.
Copyright Jack Guttentag
2002
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