Lenders and consumer advocates — rarely on the same side of the issue — are now cautioning against down payment requirements. They argue that such restrictions could limit lending, and prevent lower-income borrowers from buying homes. They also contend that the new mortgage rules put in place this year will do enough to limit foreclosures, making down payment requirements somewhat superfluous.
The arguments seem to run contrary to long-standing beliefs about homeownership. For decades, experts have emphasized the need for a sizable down payment — a rule of thumb being 20 percent — on the premise that borrowers with a sizable chunk of equity in a home are less likely to walk away when things get bad.
20% down payments have less to do with that aspect of things than they do with the basic principle of financed purchase -- the amount of leverage that the buying is carrying in the transaction.
With a 20% down payment the buyer is carrying 5:1 leverage. This is still substantially dangerous to the buyer, but it is probably manageable, provided that the income and assets of the purchaser prove up after diligent inquiry and there are no hidden liabilities that are being actively concealed.
With 10% down the buyer is carrying 10:1 leverage, or the amount that commercial banks are allowed -- in theory -- to carry. But this is much more dangerous than a bank, because the bank carries this leverage across thousands if not hundreds of thousands of individual transactions. That is, the bank has little or not "specific transaction risk" -- the risk that the one transaction in question will go bad and blow you up. A buyer, on the other hand, is inherently exposed to this specific transaction risk and this makes such a loan very dangerous.
How about 3% down? Now you're levered at 33:1, which I note is where Bear Stears and Lehman were just before they blew up. That's a literal ticking time bomb.
20% down isn't a panacea. 5:1 is still too much leverage, in my opinion, unless coupled with extremely-strict income:debt ratio requirements. The common 28/36 ratios (36% back end and 28% PITI front end) against gross income is dangerous as well if there is the potential requirement or desire to take on any more debt post-closing. Specifically, if that ratio does not already include leased or time-financed vehicles for all adults responsible for the note then the premise is potentially bogus and the ratios will get violated as soon as a car needs to be replaced (or added.) One reason for this danger is that these figures are pre-tax but we all must pay taxes. Worse, the danger gets greater the further up the income scale you go (as your effective tax rate increases) until you break into the "upper crust", which for many high-cost areas starts in the $200k+ income range. What would be better would be to keep 28/36 but make it after-tax; this would make the ratio income-insensitive and be a bit more conservative at the lower end but materially more-so for middle-income participants (where the ratios can bite you the hardest despite declaring the loan "safe.")
The other benefit as mentioned in the article is that forcing a 20% down payment to be considered a "safe" mortgage demonstrates one thing that is very important to stable home ownership -- the ability to save economic surplus rather than immediately spend it. Since homeownership is inherently an act that comes with material and ongoing but sporadic maintenance expenses for which one should maintain a fund to cover them, demonstrating this capability is a big deal. The idea that one may rely on the always-present ability to borrow when (not if!) the furnace takes a crap and requires replacement in February is both unwise and potentially catastrophic for both the borrower and the lender, since a home without heat in such conditions is likely to have the pipes freeze doing serious damage to the secured asset.
It is not surprising, of course, that the lending and housing industries are pushing back on the imposition of these requirements. After all, infinite leverage is great for prices and profits, so long as it lasts.
But it is also inherently unstable and if 2008 taught us anything it should have taught us that while it's perfectly ok for individuals to take such risks when those individuals and firms seek to or actually do transfer that risk to the public as a whole via taxpayer bailouts or subsidies we must, as a body politic refuse.
20% down, 28/36 after-tax ratios against verified income folks for those who want to claim "qualified and thus safe" mortgages, with those verifying the claims subject to both civil and criminal fraud prosecution for any material misstatement of fact.
Anything less is a joke and you will get the bill for allowing it though.
After a devastating cycle of bubble and bust, the U.S. housing sector is on the road to recovery. New homes are being built at the fastest rate in years and prices are increasing across the country. Foreclosures are down and the number of “underwater” mortgages has declined by almost 12 percent since the peak at the end of 2011. Even Fannie Mae and Freddie Mac, the mortgage-finance companies in conservatorship since 2008, are reporting record profits.
What’s wrong with this picture? None of this would be possible without massive government support. Today, the government owns or guarantees about 90 percent of new mortgages, up from about 50 percent in the mid-1990s. It isn’t sustainable, let alone fiscally acceptable, for the U.S. to have such a domineering presence in what should be a private-sector function.
The biggest challenge going forward is separating the choice to buy a house from the decision to make a leveraged bet on housing prices. Right now, when a borrower puts down $50,000 to buy a $500,000 house, she doubles her equity if the value of the house goes up to $550,000. The lender, however, has no claim to any of that appreciation. Alternatively, if the price declines to $400,000, the borrower is suddenly in the hole. She has a strong incentive to default, leaving the lender in the lurch.
First, the lender always has superior information. The lending entity has the experience of thousands if not millions of loans to draw upon. The consumer has only himself and what's worse, the lender can and will actively deceive him if he's able.
For the borrower to actively deceive is a felony (Mortgage fraud.) For the lender (or other "housing professionals", such as those claiming "house prices only go up!") to actively deceive is "ordinary business practice" or "puffery."
Think I'm overstating the case? Have you ever seen a car dealer tell someone it's a bad time to buy a new car? That's what I thought.
The problem lies directly in the government "support" for this alleged "market."
In the 20s, as noted (and it's amusing how this is the first notice I've seen of this in the mainstream media!) the "traditional mortgage" was a balloon note that had to be rolled over and was typically interest-only. This was the past-day version of an OptionARM! They blew up en-masse when housing prices went down, just as did the OptionARM. I note that most of the OptionARMs were private sector loans, not GSE things.
Why should anyone care about private-sector hubris? Nobody should. What we should care about are so-called "professionals" with superior information intentionally misleading by either omission or commission the consumers who rely on them for advice. That should be treated as the criminal felony that a consumer misleading one of these professionals is!
There is no reason for the government to get involved in this at all, other than enforcing the law on an even basis and giving neither side the ability to abuse the other. I have no quarrel with prosecuting someone who misleads a lender as to their income, but I demand in turn that a lender or real estate professional that misleads a consumer as to the risks and rewards either by omission or commission that come with ownership and financing of a purchase be subject to the exact same criminal sanction.
Of course the lenders and real estate professionals don't like that point of view and have demanded, lobbied for and received protection from their deceptions while the common person is (at least in theory) punished for theirs. This is flatly wrong and utterly indefensible.
The worst part of the government being involved in the mortgage market is that it denies both the opportunity for the market to design its own solutions to funding problems and at the same time presents an overly-cheap model for funding that is not connected to the underlying risks associated with ownership of the asset in question, in this case houses.
We should kill something all right, but whether it's the 30 year mortgage should be determined by the market, not government. What should absolutely be killed is government and quasi-government interference in the private mortgage market.
If the price of 30 year money with all of its uncertainties exposed to the marketplace and not guaranteed by anyone is too expensive for buyers, they will not elect that choice. We need no government jackboot to make that happen -- the market is perfectly capable of allocating that risk all on its own.
More government socialism is not the answer, and despite the incessant lefty screaming the facts are clear in that it is exactly this distortion that was largely responsible for the bubble inflating to the degree that it did originally along with the fact that its deflation has been interfered with quite-effectively.
As a direct consequence housing, with few exceptions, remains overpriced today.
Read that: NEARLY EVERY DOCUMENT REVIEWED BY THE AUDIT TEAM INVOLVED ONE OR MORE OF THE FOLLOWING.....
Wholesale document fabrication and slander of title, imposing potential double liability on the property owners and issuance of fatally flawed deeds.
It's not your house.
It was stolen.
In virtually every case reviewed over the period of the last two years.
No, the fraud has not stopped with the housing bubble collapse. It has instead accelerated.
Oh, and the county -- one county in Texas -- was apparently rooked out of over $868,000 during the same time by these practices.
And you guys wonder why I started writing The Ticker in 2007, and why, today, given the lack of outrage and action by the citizens of this nation, including but not limited to the more than 90% return rate for Representatives and Senators, it is very hard for me not to conclude that this has been one gigantic waste of time when nobody will get off their ass and do anything about their own continual financial rape?
The difference between******and sex is consent.
YOU ARE CONSENTING!
There comes a point where cheerleading for crooks has reached the level of the absurd.
One reason for optimism in the New Year is the housing market, which continues to heal despite the weak economic recovery. Case-Shiller, Lender Processing Services and other data trackers are reporting recoveries in many regions. Even more noteworthy is that the rebound is strongest in states that let lenders enforce contracts.
We're referring to the difference between "nonjudicial" states that have streamlined foreclosure procedures and the 23 "judicial" states that force lenders to go to court to enforce mortgage contracts. Prices are stabilizing in the former but still faltering in much of the latter, which isn't surprising, except to politicians. Housing markets can't clear until lenders can foreclose on delinquent borrowers and prices fall far enough to attract buyers who can afford the mortgage payments.
That's because in judicial states, which the lenders knew were judicial states when they made the loans, they can't generally prove up their claims in a lawful sense -- so they manufacture documents they don't have (on purpose) and then hope nobody looks too closely (or their opponent doesn't even show up!)
The Journal goes on to "decry" that these states take longer and people can live in the house without paying. But certainly this risk was known to the lender, with superior information and experience, at the time they made the loan, yes?
So where's the beef?
Look, if the lenders had their paperwork in order because they didn't shred or lose it in the first place, and could actually show up with a nice documentary trail showing every assignment, that they hadn't been paid off by some other instrument or game they played, and that in fact the alleged trust they're suing in the name of actually has the paper in question these cases would go pretty quickly -- and there would no big backlog.
But they didn't do that.
They could have also made prudent loans in the first place, instead of writing not one but two mortgages on two properties for over $1m each to someone with $100k of income. Yes, that happened around here in Florida, more than once, and then the banks are surprised when the borrower can't pay?
Was that an actual loan or was it some sort of scam where they found a rube to pass the paper on to at par (and then lost it on top of it!), played "pinky promise" and then when the expected default occurs they cry poverty and "injustice"?
I say that those who pulled some hinky crap shouldn't get rewarded for it. The putative homeowner who "bought" a house they can't afford shouldn't get to keep it. But the putative "lender" who didn't really loan anything as he had a buyer for the paper all lined up and then intentionally failed to properly transfer and record everything like he was supposed to shouldn't profit from this bogus deal either nor should he be able to abuse the courts, committing unbridled and outrageous acts of perjury.
Further, if said bankster shows up to sue for foreclosure he should have to prove up his case like anyone else, complete with full proof of standing including the original paperwork with all transfers documenting that it was assigned as required by law into the alleged putative trust that claimed to be holding it at the time of default!
If they can't do that then the court is simply rubber-stamping frauds that are now being whitewashed in the name of "expedience." And the reason we're seeing such a big backlog here in Florida is that these institutions come into court with intentionally incomplete paperwork, knowing damn well they can't prove up their case, and hope for a Judge who's got vodka in his water glass on the bench.
The problem isn't judicial foreclosure.
It's that there's so much damned fraud that neither side deserves to have any of their prayers for relief heard, and neither deserves to "win."
When you ask Judges to play Solomon it takes time, but the entire responsibility for this state of affairs lies with the banks -- not the borrowers.
“We need to look hard at some of the old assumptions and ask the question is homeownership the right solution for everyone?” Moynihan said today during a speech at the Brookings Institution in Washington.
Of course it's not.
Lenders need to carefully underwrite loans and ensure that borrowers have an incentive to maintain their payments. Still, he said, “I don’t think there is anything magic about a 20 percent down payment; 10 percent seems reasonable.”
Considering that you have 6% that disappears every time you transact (in the form of Realty commissions, plus a bit more for fees, costs, tax stamps, title policies and similar) 10% is dangerously close to zero in real terms.
The 20% down payment is not just about protecting the lender from the risk of value decline, although that's certainly a part of it. A 20% down payment makes it relatively easy to argue that the entirety of the created credit money is offset by locked-up asset value in the form of the capital represented by the house. In addition it limits leverage in home ownership to 5:1 and it is the limitation of leverage that holds down price ramps, making housing more affordable for everyone!
After all if you don't own a house you want prices to be low, not high!
The 20% down payment also shows that you can save back a significant amount of money. This sounds like "no big deal" but in fact it is a very big deal. Houses come with significant expenses and they're ongoing expenses. A house needs a new roof, furnace, water heater, A/C unit and carpeting from time to time. Your kid might break a window that needs to be replaced. Not only are there calamities (which you can insure against in whole or part) but there are ordinary costs of upkeep and maintenance that must be performed and if you're going to own a house you need to be able to budget and sock back the funds to handle those expenses as they arise.
Some people will argue that you can just borrow more and more money as necessary to fund those things, but what happens if your roof needs replaced while you're unemployed and thus don't qualify for a loan? Or if your furnace craps out in the middle of February, your credit cards are maxed, and you need a new one right now or you'll freeze?
The proved ability to accumulate a significant amount of capital is utterly essential to sustainable, and thus successful, home ownership. A 20% down payment made with your own funds that you can trace the provenance and accumulation of demonstrates your ability to accomplish this essential task.
Finally, home ownership makes labor far less mobile, and for some people this is just a bad deal all around, especially during difficult economic times. If you "own" a house but will lose 6% of the value in fees and costs selling it that grossly inhibits your ability to move where the jobs are. During good times this is not a big problem as you are likely to be able to find a better job (or any job!) where you live, but in tough times mobility is an asset.
Government, for its part, needs to get the hell out of the system. All it has done is distort and damage the public at-large, and it will continue to do so, because all attempts to "expand" home ownership involve destroying or ignoring one or more of these important metrics.
Better late than never Brian.
Where We Are, Where We're Heading (2013) - The annual 2013 Ticker
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