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100% Mortgage Loans: Blessing or Curse?

100% Mortgage Loans: Blessing or Curse?

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



Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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