I was reading another blog here on AR and one of the posters said they thought it was a sin to offer 100% financing. I purposely left the persons blog off because I didn't want it to appear I was calling them out. That is not my intention. I felt it was something that was worth addressing.
IMO your position on this topic depends on who you are trying to most protect. As a lender I feel I have a responsibility to deliver good quality loans to my investors. I also have a responsibility to my client to get them into the loan that is best for them in their particular situation.
From a lender's standpoint 100% financing is very risky. The borrower doesn't have any skin in the game and there is little to no margin for error to the lender. That is why normally they want pretty good credit, they charge a higher rate, they either defer their risk with Private Mortgage Insurance or by having a 2nd mortgage. Now since I am not the one with the gold I will let them make the business decision to do this or not, they wouldn't offer these loans if they didn't think they were profitable. So as long as I am delivering what they ask for I have no problem delivering 100% loans.
The client on the other hand is being sold a bill of goods thinking that the best way- the cheapest, safest, most efficient way to buy a house is to put as much money down as possible, get the shortest term loan they can (since that loan normally has the lowest rate) and then if at all possible pay extra principal payments to get that house paid off as fast as possible.
See for a majority of people it will take 15 years or more to pay off their mortgage so for that 15+ year period they are at more risk of losing the money they have tied up in their investment (equity in the house). Since statistically they will be in their loan for 5 years or less (80% chance) they will probably move in 7.1 years (NAR says) then they won't be in the house when it is paid off anyway.
Think about the family that has very little in savings, but just sold their house has $65,000 wants to buy a $300,000 house with 20% down, a 15 year loan and pays the $5k to cover closing costs. A great deal for the client? Right?
Well what if in 3 years Mr. loses his job and since Ms. is a stay at home mom they just lost their only income source. Now they should be fine with a $204,000 balance and a house worth $318,000? Right? Except they have been funneling all their extra money to pay that 15 year loan they don't have but $3,000 in savings and about $25k in a 401k. They can't make it a month with that $3,000 and their $2300 house payment the $1,400 payment on their $45,000 in debt (that was $1,200 on $30k when they bought) and what it costs just to live. They cash in the 401k after the 20% tax and 10% penalty they have $17,500 so they can make it maybe 5 months. He tried to get a loan with all that equity, but without a job he couldn't get a loan.
The market was soft and they have to severely discount the house to avoid foreclosure and the week before the house was to go to sale an investor finally offered $225k for the house so they were able to sell it 11 months after losing his job- he paid the lender and his real estate commission and walked away with nothing. So he ruined his credit, lost his $60,000 down payment, $36,000 in principal reduction via the 15 year loan, and $18,000 he thought the house had appreciated- so he lost $114k and his $25,000 401k account. Wait there was some good news he got a job in month 14 making more money than he was before.
Good thing for the client they put 20% down and got that 15 year loan, it really treated them right didn't it?
What if instead they financed 100% on one of those horrible interest only loans? They pay off their consumer debt and their after tax difference in payments between what they would have had with their debt and the 15 year loan with 20% down and paying off all the debt and 100% I/O financing they lowered their payments $1,535 per month. They invested their remaining $35,000 (they negotiated the seller to pay the closing costs) and the $1,535 in a safe conservative investment earning just 6%. In 3 years they would have had more than $103,000 in that account. So when he lost his job he could easily make his payments for a long period of time. Since it took him only 14 months to get a new job he needed a little more than $45,000 out of that EMERGENCY account, but he still had $64,000 in the account, he still had his 401k worth $25,000 and he still had his house. Oh and his credit is still perfect.
So let's recap doing everything in the best interest of the bank- 20% down 15 year fixed this family lost $139,000 ruined their credit AND lost their house. Yet with 100% financing and a PLAN they only were down $45,000, their credit is perfect, they still have $89,000 of their wealth AND they still have their house. Not to mention that they had little stress during this whole thing. Just an FYI if nothing bad had happened they would have had enough to write a $300,000 check for their house at 9 years 8 months vs. 15 years in the other plan- if we go out 15 years they would have had $532,300 in that account or a $232,300 more than with the 15 year loan.
I did use an example of someone with a good sized down payment, so let's take a quick look at lower down payments. If 100% is so bad what type of protection does 5% down give? If the above scenario had the same situation with only 5% equity what would have changed? Well if they couldn't sell their house for more than $225k they would have lost their house to foreclosure, same with 10% and maybe with 15% they might have been able to negotiate a short sale to avoid foreclosure. They still lose most of if not all of their wealth and their credit is still ruined.
When you look at worse case scenarios unless the borrower has a ton of cash available to tap if they have financial troubles everybody would be better served from a "risk management" standpoint to put no money down, get interest only financing and invest the down payment and any monthly after tax savings into a safe conservative investment. They would have a much better chance to weather a storm. You know they say the worst thing about losing your house to foreclosure is losing your house to foreclosure with all your money tied up INSIDE the house.
Personally, if I structure deals like this we are actually finding a way to give more protection to BOTH the client and the lender, because if the client can weather the financial storm then the lender continues to get paid and the client protects a majority of their wealth, their credit and they keep their house.
So I guess 100% financing is perfectly sinful, just like enjoying that bowl of your favorite ice cream with your favorite topping WITHOUT worrying about gaining weight. :)
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