Down Payments and Risky Mortgages
Down payments and risky mortgages — of course the down payment matters. Winning Mortgage, Winning Home covers a variety of ways to manage the down payment amount against the loan pricing. The interest rate paid on a loan has a detailed scale of penalties covered in the book and the book provides insights on using them to your advantage.
But not all down payments are created equal. Many loan programs are designed to help with a down payment or allow alternate sources of down payments. Those with the lowest down payments are the riskiest, not just for the lender, but also for the borrower. While Winning Mortgage, Winning Home walks a borrower through the penalties, risks, costs and challenges at various levels of down payments, the source of a down payment creates additional risks to the borrower.
Down payments come in many flavors. The real down payment amount goes beyond what many consider the down payment. The second, and perhaps a more costly component, arises from the mortgage itself and all of the closing costs to obtain a mortgage loan and pay for transaction costs of a purchase. Examples of the impact of those costs are explained with examples in the book.
Down Payment In Cash
The first option is to pay cash from savings. Pretty straightforward. A borrower was able to save enough funds for the down payment and closing costs. This doesn’t matter whether the down payment is 3.5% or 20%. However, a lower down payment creates more risk for the borrower. If a borrower saves up 3.5% for a down payment plus closing costs, this creates a starting point for the highest priced loans in terms of interest rates. Rarely will a buyer be paying less each month for the principal+interest+real estate taxes+property insurance+private mortgage insurance than was being paid for rent. This means monthly cash out the door is higher than before buying a home.
If saving money was a challenge prior to buying a house, it is now more of a challenge. Winning Mortgage, Winning Home demonstrates how the budget the lender allows for a mortgage is different from the real monthly budget a borrower needs day to day. Borrowers frequently qualify for more loan than is truly affordable. Then something breaks down and requires repair at a significant cost and now the borrower is in credit card debt at 21% to 27% or more. As a recommendation, if a borrower can only save 3.5% for a down payment, it is not yet time for a mortgage.
Other Down Payment Options
The second option adds on to the first option. This concerns gifts to the borrower towards a down payment. Does a borrower save well and will continue to do so with a mortgage costing more each month than the prior rent? If so, the borrower likely will continue to perform without substantial risk. Does the borrower need a gift to get to the 3.5% down payment level? If so, risk increases and may signal that the loan may go delinquent and possibly be foreclosed. FHA loans fit this category.
The third option concerns seller paid closing costs. FHA allows the seller to contribute a limited amount to the buyer to be applied towards closing costs. Winning Mortgage, Winning Home walks borrowers through the risks here. Like the second option, a significant risk arises that the loan will go delinquent and possibly be foreclosed. The borrower also likely overpaid for the property in order to get the seller contribution.
Grants and Tax Credits
The fourth option concerns grants and tax credits from third parties, non-profits, or governmental entities. Local and state agencies currently provide the most down payment assistance in grants. However, the structure doesn’t take as much taxpayer funding. The down payment comes from the agency, but with a loan attached. These loans generally have a slightly higher interest rate or a form of second lien loan. The housing authority can then sell the loan in the secondary market at perhaps a higher price. This recovers some or all of the down payment assistance provided and minimizes taxpayer subsidies. Last year, more than 122,000 borrowers received almost $1 billion in assistance. That equates to about $7,500 for each borrower. A borrower who saves effectively and qualifies will benefit from these credits or grants.
Three different home buyer assistance bills or grants were being considered during the last year in Congress. The effect of a grant without demonstrated budgeting and saving ability will act like a Nehemiah program discussed in Winning Mortgage, Winning Home. Without a consistently demonstrated saving pattern, this can be the most toxic to borrowers. Unfortunately, the bills in Congress require massive taxpayer subsidies and will be highly toxic to borrowers. Destruction of credit and ensuing foreclosures will be problematic under all three proposals. Good intentions, bad unintended consequences.
Lower Default Risk
Regardless of the risk, borrowers who have followed the Winning Mortgage, Winning Home have an advantage. Winning Mortgage, Winning Home provides effective budgeting recommendations and planning. Readers and followers will substantially lower mortgage default risk of any kind.