The way we talk about Real Estate today is vastly different than a few years ago. This week we are discussing the common phrases we previously used and why they are obsolete today.
“You don’t need a down payment.”
Traditionally, the purpose of a down payment is to reduce the bank’s lending risk. It shows that the borrower has enough self-discipline to save up 20% of the purchase price of a home.
More importantly, it means that the borrower is likely to keep making his mortgage payments even when times are tough because he has already put a lot of his own money into the house.
When banks started giving people mortgages that didn’t require a down payment, buying a home started to feel more like leasing an apartment. Even owners with fixed-rate mortgages had little home equity since most of the mortgage payment for the first few years is interest.
When housing prices dropped, owners started sending jingle mail to their lenders. So what if they could still afford the monthly payments? It didn’t make logical sense to keep paying for a depreciating asset that they owned so little of, borrowers reasoned. The sting of a credit score ruined by foreclosure wouldn’t last as long as the burn of paying $500,000 for a $300,000 home.
The lack of down payment is also one reason why so many homeowners ended up underwater. If you purchase a home for $200,000 with no down payment and the market value of your house drops to $160,000, you can’t sell the house because you can’t pay off the mortgage (unless you have $40,000 sitting in the bank). If you purchase a home for $200,000 with a 20% down payment and the market value drops to $160,000, you still have the option to sell at a loss. Most people who didn’t make down payments didn’t have money in the bank, though, and when they needed to get out of their homes, they were forced into credit-damaging short sales and foreclosures instead of having the option to sell.
Tomorrow let’s talk about refinancing and does it really work?!