It makes sense. If we are to believe that there is a simple preventative measure which will reduce the chances of another mortgage market meltdown, “skin in the game” is a good place to start. Getting rid of 100% financing is a foregone conclusion. But what about the 97%, 95%, and 90% loans? It requires little change in the market for a homeowner to claim, “I’ve lost all my equity” when it was only 5% to begin with.
One of the many dynamics causing increased foreclosures is the very perception on the part of first time homeowners that because their home may be worth less than they owe, they should lay down the keys and walk away. Nothing could be further from the truth. Bear in mind that I am not speaking of those that have toxic loans with payments that have escalated beyond a homeowner’s means. I am referring to people that are getting along OK with a fixed rate loan and payment, but are throwing in the towel prematurely, thanks in part to the media that is telling them they were losers to start with because they bought with low, or no, down payment mortgages.
Right now, the Democratic House of Representives is considering lowering the FHA down payment requirement from 3% to 0%. The Seante is working on a 1.5% requirement. John McCain is touting the need to increase the downpayment to 5%. (See Ken Harney’s Sunday Seattle Times article) I think they’re both wrong.
FHA loans have been a special resource for first time buyers for many years. They are not part of the problem, thus I believe that they should not be tapped, or modified, in order to be the cure. It is a staple of the home loan industry that isn’t broken, so why fix it. A buyer needs to come up with about $19,500 (3% down + closing costs) to buy a $300,000 home. Here is a breakdown:
- $9,000 down payment
- $4,500 One Time Mortgage Insurance Fee [1.5% of loan amount]
- $3,000 Loan Origination Fee [1% paid to who put the loan together]
- $2,000 for Title Insurance and Escrow Fee
- About $1,000 for “Pre-Paids” i.e., monthly mtg insurance and interest
A couple of wrinkles that are new:
- The 1.5% One Time Mortgage Insurance Premium MAY be added to the base loan amount of $291,000, thus making the total loan amount $295,500
- The borrow will pay Monthly Mortgage Insurance in an amount equal to 0.5% of “base” loan amount: 0.5% of $291,000=$1,455, divided by 12=$121.25
- Lenders MAY charge a “discount fee” of 0.5% or more, of the base loan amount. This will vary from lender to lender and is something that borrowers need to look out for.
$19,500 buys a decent car. It shouldn’t be too much for someone that is serious about buying a home. Yet the buyer has enough “skin in the game” that will compel them to improve and maintain their property and not throw back the keys at the first sign of negative market changes. With the down payment increased to 5%+closing costs, the same buyer would need over $25,000 to buy the same $300,000 property. It is my opinion that crossing the $20,000 line is both a financial and psychological barrier for many would-be home buyers.
On the other hand, reducing the down payment to 1.5%, if combined with the option of adding the 1.5% Mortgage Insurance Premium to the loan amount, makes it too easy for buyers to get themselves into trouble, which in turn also makes it too easy for them to walk away. It would effectively be a return to 100% financing.
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