First and foremost, keep in mind that Texas is a foreign country. We only joined the union like 6 years ago so we still do things a mite different down here. My point is that there's no need to shoot holes in this proposal because it doesn't fit Arizona. ok?
First, some background. Every other state in the US of A allows a homeowner to borrow up to 100% of the equity in their home. Mortgage Lenders may determine if a particular applicant is eligible for that much financing, but my point is that the state stays out of it.
But that's not how it works down yonder in Texas. In 1997 we finally allowed homeowners to borrow agains their equity for purposes other than dedicated home improvement, settlement of equity from a divorce or payment of tax indebtedness. (those 3 reasons were allowed prior to 1997). Although one might rejoice at Texas joining the 18th century in regards to homestead lending....don't be too hasty. The legislature, due to concern of predatory lending and outside lenders "raping" the equity of good hard-working Texans, decided to protect the consituency. Therefore, a homeowner in Texas must keep 20% of their equity in the home at all times.
Let's work an example, shall we?
Home Value $185,000 (for you West-coasters...yes, we can buy really nice homes here for that little...just bear with me)
Current Loan Amount $119,000
80% of the home's value of $185,000 is $148,000. This is the maximum indebtedness allowed against the home. So the most equity the homeowner can borrow is $29,000 ($148,000 - $119,000).
On to the point of this post.
Making a down-payment of greater than 20% makes no sense to me in Texas. I'll give you 5 reasons why:
- In terms of gaining a better interest rate, 5% down payment or 20% down payment would be priced the same in nearly every mortgage loan scenario. Perhaps 10% down would benefit you over 5% if you need stated income or some other type of non-conforming loan. However, overall your interest rate benefit of a greater down-payment stops at say 10% - so any additional you pay down doesn't save you in rate.
- 20% down payment does get you out of private mortgage insurance requirements although that may or may not be worthwhile. I won't go into 1st and 2nd combination financing vs. one loan with mortgage insurance but look at it in this sense. Let's say you are buying a $200,000 home and the interest rate with 10% downpayment is 6.00% so the monthly payment of principal and interest is $1,079 + private mortgage insurance of $58.50 per month (total pmt = $1,137.50). If you put down an additional 10% (total of 20%) you removed the $58.50 per month mortgage insurance and you are borrowing less so your payment is only $959. While that is a savings of $178.50 per month it cost you an additional investment (downpayment) of $20,000. If you live in the home 6 years your $20,000 downpayment saves you $10,710. That may seem smart on the surface but a compounding rate of return of 7% on that $20,000 would have gained you the same amount in capital gains.
- Texas is a non-judicial foreclosure state. What does that mean? It means there is no judge or courtroom hearing required for a foreclosure to happen. It is all spelled-out in the deed of trust that few actually read at closing. Basically, non-payment of your note kicks in the foreclosure process and from there it is relatively easy for lenders to foreclose. No lender WANTS to be in the foreclosure business, HOWEVER, most will move more aggressively when there is greater equity in the home. If you buy a home with 100% financing and miss 3 payments due to unexpected illness, job layoff, etc. the lender will work with you primarily because they will DEFINITELY lose money on foreclosing your home. If the same situation happens and you have greater than 20% equity in your home, the lender is more likely to move rapidly to foreclosure before you trash the house.
- Investing in your primary residence is a low return investment combined with terrific penalties for getting your money out. How so? Think of it in these terms. You invest $20,000 into a fund that has a history of 2.5%-3% performance over the past 7 years. If you want your money out early, you have to pay a 6% fee to the broker and find someone not only interested in your shares but qualified to buy them. If you need the money quickly, you will have to discount your share value in order to sell quickly. The value of the investment is also dictated by other market factors like interest rates, unemployment, etc. and if you need to sell at a bad time in the market then that is a risk you take. Do you still want to invest your $20,000 here?
- In Texas, you can't get 20% of your equity back until you sell the house. So if you put 20% down it's gone and is stuck growing at the rate of appreciation. If you put more than 20% down you can access the rest of your money but only by incurring financing fees to borrow it back at a rate higher than that of your first mortgage.
This is the type of analysis and the consultative approach I take with my clients. Every situation and every state is different so one-size-fits-all bullet pointed "How To" lists should be taken with a grain of sensibility.
©2007 Ken Stampe
Ken Stampe is a Mortgage Loan Originator, Mortgage Author and Mortgage Loan Officer Instructor living in Dallas, TX. Ken provided his first client a mortgage loan in 1996 and writes about home buying and mortgages to help clients make smart home mortgage loan decisions. Contact by email at Ken@KenStampe.com
What resource do SMART home buyers use?... Mortgage Calculator Bank.com
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