Thursday, July 24, 2008

Down Payments and Risk

There was an article Tuesday, July 22, in the Washington Post which discussed how DAPs (downpayment assistance programs) might be nixed with the passage of the current housing bailout bill:

Washington Post: Congress set to Limit Down-Payment Assistance

Before we get started here, let me state this clearly: I am a rotten bastard, and do not believe that everyone should (or can) be a homeowner.

Oh, sure, in a perfect and risk-free world then perhaps down payments would be unnecessary. But our world isn't perfect, and it certainly isn't risk-free. (As recent news so clearly suggests.)

Anyhow, in the above article, I was nearly ushered into full-rant mode by a few of the quotes used in the story.

But supporters of this kind of [down payment] assistance said it meshes with the FHA's mission to serve low- to moderate-income people. While the system may have its problems, they say, it should be fixed, not abandoned, so that people like Tanika Warrior are not shut out of the market.

Warrior and her husband, Jimmy Hicks, suffered housing sticker shock when they moved to the Washington area from Arkansas a few years ago.

The couple, recent college graduates, had depleted their savings on tuition and care for their newborn son. But they had steady jobs and did not want to keep sinking money into rent, Warrior said. They also did not want to put off buying a home because they were not convinced that their finances would be stronger in a few years.

"We don't want to throw money in a hole," said Warrior, 24, a federal patent examiner. "My thing is, we pay our rent every month and we've never been late, not once in five years. If we can pay our rent every month, we can pay our mortgage every month."

Yeah, see, what this college grad and recent dad doesn't yet grasp is a thing called risk. As a guy who's been rabidly watching the housing bubble go bye-bye these last few years, I will state here that "paying rent" and "paying the mortgage" are alike only insofar as they both involve forking over money to someone else on a regular basis.

That's where the similarities stop.

Let's pretend Mr. Hicks stops paying his rent. What happens? Give it a few weeks, or months, and his landlord comes along and plays the eviction card. Mr. Hicks takes the proverbial hike. Mr. Landlord (who already owned the place) cleans the place up, maybe, puts an ad in the paper, and soon (probably) finds a new tenant to shack up and take on the rent.

Landlord's Risk: Probably not too much, in terms of time and/or income. If the renter scoots one day, well, hopefully Mr. Landlord was wise enough to collect a month's rent or more upfront. Just in case.

Renter's Risk: Little to none. When something breaks or repairs are needed, he calls the landlord. When it's time to ditch the place, he loses his initial deposit. Maybe.

Now let's say Mr. Hicks stops paying the mortgage on the Dream Home he and his wife so luckily qualified for thanks to scams like "down-payment assistance." There really is no down payment (read: borrower "skin in the game") in such cases, mind you; the money simply comes from the seller via an inflated sales price and a circuitous money-laundering route. Think high appraisals and dodgy "non-profit" assistance companies, for starters.

Lender's Risk: High. When things go bad, the lender must resort to foreclosure (costly), property upkeep (costly) on a place he never wanted to own anyway, and (oh yeah) risk the loss of tens or hundreds of thousands of dollars of value (watch the news much?) when he finally unloads the property on the market.

Buyer's Risk: Significant to high. For starters, who ya gonna call when the roof springs a leak? That's right: MasterCard. Whose credit rating hangs in the balance when the Buyer's checking account runs short? Who's on the hook for property taxes, upkeep and maintenance, and dodging annoying neighbors? If you answered "buyer," you're a winner. Of course, if housing prices ever went a direction other than UP, then you could throw "price risk" in here, too. But since we know THAT never happens...

Anyway, what Mr. Hicks is missing entirely is this: From the "buyer side" of the transaction, "paying rent" and "paying the mortgage" don't look all that different. Both require the obligatory once-a-month check. From the landlord/lender side of the table, though, there's this thing called risk. And it's a huge consideration. Or should be. (It wasn't the last few years, thanks to bubbledom. Which is why words like "subprime," "Alt-A," "walking away," and "billions in write-offs" splatter so many headlines these days.)

There's a reason the standard mortgage down payment used to be twenty percent. Twenty percent means the borrower has significant "skin in the game" and won't take her responsibility as homeowner lightly. Twenty percent means the lender has significant cushion against falling home values should the borrower default at some point.

Additionally, "twenty percent down" means that borrowers don't go buying homes that are light-years above their means. In contrast, the Washington Post gives us the Shermans:

Salmineo Sherman Sr., who recently used seller assistance to buy his first home, is not tuned in to the horse trading on Capitol Hill.

But yesterday, he said he felt lucky that he bought his seven-bedroom house in Clinton this month. Without seller assistance, he and his wife would not have been able to close the deal. They have six children, two of them grown.

"I do not see myself as any risk at all because I'm not stretching with this house," Sherman said. "We can afford the monthly payments. . .. We're staying put, right in this house."

Hmmm. Let's see:

Six kids, including two grown.

Seven bedrooms.

Picturesque home.

Decked-out kitchen (note the article's slideshow).

And not enough savings for a minimum down payment on any of it.

Not stretching, huh? Someone — anyone — please show me where requiring "seller assistance" to purchase a seven-bedroom McMansion equals "not stretching."

Call me crazy, but no matter how bulletproof Mr. Sherman believes his American Dream is right now, something tells me the dreaminess of it all will quickly dissipate the minute ol' Murphy strikes. And Murphy will strike.

We're told that Mr. Sherman's been "affording the payment" in this "first home" all of one month — if that. And since he apparently couldn't come to the table with a requisite down payment of his own, we can be fairly assured that his household's ability to actually save cash is ... well, iffy. At best. (And with six kids, who's surprised?)

From where I sit, it takes more than one month of living in a place to have any idea of what it's really gonna take to "stay put."

But Who Has 20% of $400k to Put Down?

Yeah, I know. Realistically, what Joe Sixpack can come up with $80k as a down payment on, say, a $400k house?

One who can truly afford that house. That's who.

Note that this Joe Sixpack probably isn't a first-time homebuyer, nor is he a single dad with three live-in kids and a Yorkie.

Which is exactly as it should be.

But $400k Won't Even Get Me a Shanty Where I Live!

Then prices need to come down. Way down. Which, I've heard, is happening as we speak. Lucky you. Of course, you could also move.

But that would be hard.

Just like saving.

So You Want to See Minimum 20% Down Again?

Nope, though who knows how lending will evolve from this point. When my wife and I bought our home, it was our first, and we had to put only 3 percent down. At the time, that was something just over $2k. If I recall, our household income was in the low- to mid-$20s. We saved the $2k and made it happen. (I reiterate here that it's awfully nice to reside in a low-cost-of-living state.)

Unlike some folks, apparently, I don't believe that banks' requiring minimum down payments WITHOUT some sort of DAP involvement is just another way for "The Man" to "Keep You Down." That's crap, and I'm tired of the implication of it from various outlets.

Having some sort of significant down payment — and yes, that can be as little as 3 percent of the purchase price, provided the funds are the borrower's — shows that you have at least some control of your money, and at least some capacity for thinking ahead and saving. I like to think of having good credit and a stable work- and bill-paying history as "being qualified" to enter the American Homeownership Ball. But just being "qualified" doesn't get you in the door.

For that, you also need a decent down payment. Somehow, some way, you have to prove that you can control your money, and having a savings stash is as good as any.

As a 12-year homeowner, I can assure you: That ability to save will come in real handy when homeownership risk rears its ugly head.

Labels: ,

— Posted by Michael @ 9:20 AM


Good rant. Shelling out money to a landlord for rent is absolutely not the same thing as being on the hook for a mortgage, taxes and upkeep. I’ve been a homeowner (and landlord) for 22 years, and I definitely know the difference.

If a buyer has little or no savings to buy a house, and nothing set aside for maintenance or emergencies, maxed-out credit cards, etc.; then allowing them to buy (er, use) a house under any type of loan program with little or nothing down is pure insanity.

Just one little disaster or major expense could boot them over the edge and leave a wake of shoulda-coulda-woulda’s behind them. And who’s gonna pick up the tab after they dump that over-priced house and hit the streets? Yup, say hello to Mr. & Mrs. Taxpayer (umm, that would be us) and higher taxes, inflation, investment losses, indigestion, depletion of our ozone layer, acne, smelly feet, etc., etc.

With no down payment, a buyer doesn’t have a dog in the fight, so why not walk away, and umm, go back to renting? And what the heck – if they can’t afford the rent, they can probably find a government program willing to pay it for them (they might have to pump out a few extra kids first – that’s always a smart move when you’re in debt). Oh man… I’m getting teary-eyed just thinking about it… waving my little flag… it’s the American way.

Anonymous Anonymous
, at 2:00 PM, July 24, 2008  

I bought my first house at 23 years old with 3% down. It was tough coming up with that 3% because up to that point I'd had no idea how to manage my money, but somehow I scraped it together & was so proud of myself for buying a house by myself just a couple of years out of college.

A couple of years later, I sold that house, and rented for a while. I eventually decided to buy a condo, and was able to come up with 5% down - an easier task since I'd learned to manage my money better.

Fast forward another 4 years - and I sold the condo & bought a house with 10% down. This was pretty significant to me since the home I own now cost nearly twice as much as my first & second homes put together.

With that said... I think that's the type of scenario that the FHA and these housing programs were meant to support. People just starting out, who can be responsible homeowners, and eventually get to the point where they can continue to increase their ownership stake in a home & create stable communities. Having been there, I definitely understand the type of mindset that the 20-somethings have around homeownership-or-bust.

It is a really daunting task to save such a significant amount of money at once & not touch it. Some people can do it easily - there's your 20% crowd; others need a little bit of coaxing & cheering along the way - which are the 5-10% folks; and still others are just not going to be successful at the venture even if you gave them the house for nothing.

I think what the government tried to do was target those folks in the middle who could do it with just a little push, but they overshot the mark by making it much too easy, much too affordable.

I think buying a home should be a little bit of a stretch, a little bit of a sacrifice for someone to do. Not a stretch in the sense of being able to afford the monthly payment, but in terms having to put something in and having sacrificed some of their lifestyle to be able to do that.

So while I'm generally supportive of low-down payment assistance programs, I think they should include mandatory coaching sessions on how to be a homeowner & what to expect, and they also should require people to have a 1% reserve separate from the DP for maintenance/repairs to qualify for assistance.


The very reason prices rose as high as they did is that the credit market was very loose. If everybody is given easy access to money, then more people can afford a more expensive house and the prices go up accordingly. If 20% were required again then price would continue to come down and they would be back in the range people could afford. This is bad news for those who bought houses in the last few years, but is necessary.

Anonymous Anonymous
, at 8:25 AM, August 06, 2008  
** Comments Closed on this Post **

Thoughts on my personal finances, goals, experiences, motivations, and accomplishments (or lack thereof).

My financial life began turning around when I took responsibility for it.
— Dave Ramsey


Start (2005-12): ~$21,900
Currently: $0
[About Our Debt Paydown]


Savings Goal: $15,000
Currently: ~$15,115
[About Our Liquid Savings Goal]