The downpayment dilemma

Bloviation Alert: This post will contain the blogger's opinions and analysis.

The tightening of lending standards is making it more difficult to get 100% financing -- and impossible if you have a low FICO score or can't document your income. When lenders start talking about 10% downpayments, some of you probably start nodding your heads in agreement -- "Yes, that's reasonable." It may be reasonable, but in this state it is not possible for many potential buyers. 

The median down payment for first-time homebuyers in California was $10,000 last year -- which translates to about 2% down on a $450,000 home, the median price for first-time buyers;  40% of first-time buyers put nothing down. "Well," you may say, "they need to start living on a budget and saving their money."  Again, that's reasonable, but it's probably not going to happen. Nothing in recent American economic history indicates that it will happen. We are not a nation of savers. You may think that is wrong, or foolish, or unsustainable, but it is fact.

Is it likely to change? Will Americans now suddenly see the light and start saving? We doubt it. We think it is more likely the financial industry will invent new ways of borrowing.  Imagine all the forces that want Americans to keep on spending, starting with corporate America -- including its many close friends in Congress, the White House, and every state legislature in America. Add the credit industry, the automotive industry, the real estate industry, the banking industry, and the greatest advertising and marketing machine the world has ever known, which spends every waking minute convincing Americans there are new products we need and can afford.

Now, then -- who's making the case for saving? Anybody? ... Anybody? ... Bueller?

Now, your take? Your thoughts? Insights?

Comments

[investorguy]

It's just not going to happen in LA. The cost of living here is too high to allow most people who could scrape together $10,000 somewhere else to find $40,000 here in less than 10 years.

Consumer home buying here, for better or worse, is driven by anticipated equity. Investors know that you make your money when you buy, and realize your profit when you sell. Consumers haven't been educated the same way.

For consumers who want to get smart and start thinking like investors, there will be some excellent opportunities over the next couple of years. And if you can't buy here, buy in other markets, and use that equity to fund your home here.

There are plenty of markets where you can buy REOs with a couple thousand down,and pick up tens of thousands in fast equity on income-producing rental properties that they can use as a down payment here. That's a viable alternative to saving, and I know several folks who are taking just that route, very successfully

And fear not, lenders will create new products to replace the sub-primes, no docs and zero downs -- it's what they do 8-).

[SD Dan]

Why can't people save $30,000 for a down payment?

People are more than capable of 'scraping together' sums of $20,000 or $30,000 when they buy that shiny new car on a car loan.

Even saving $40,000 over ten years works out to saving $260 a month at 5% interest. That $260 a month is only 7% of take-home pay for someone making $40,000 a year.

It is doable.

[Anthrodiva]

We save - but primarily for retirement. We also save for consumer items and vacations, which we pay cash for. There are programs to get first-time home buyers into homes with little or no money down. You can get student loans, but as Suze Orman likes to say, 'no one is going to lend you your retirement!"

The poster above is nuts if they think people put 20K down on a car - most luxury cars around here are going to be leased. More affordable cars come with 7 years payment plans - and 0% down.

Let's stop crtiquing people about not saving. Like most statistics, this one is highly suspect.

[Pete Viles]

SD Dan says "It is doable," and I agree, it can be done. What I'm saying is, I don't think it will be done, at least not in significant numbers. Most Americans buy on credit, and they don't save. There is zero national will on this; who's the presidential candidate who is going to say, "We need to save more in this country and sacrifice more and put off those big purchases until we can afford them."? I'd bet on a government response that is more along the lines of the "Helping Hand Home Ownership Opportunity Act," some form of downpayment assistance.

[AnnS]

"There are plenty of markets where you can buy REOs with a couple thousand down,and pick up tens of thousands in fast equity on income-producing rental properties that they can use as a down payment here. That's a viable alternative to saving, and I know several folks who are taking just that route, very successfully Posted by: investorguy "

You are deluding yourself that "thar is gold in them thar hills out there somewhere."

In my area, which has a median family income of $52,000 and drowns in tourists and summer people for 3 months of the year, there is virtually nothing that can be purchased as income property that will yield a positive cash flow.

There are houses priced under $200,000 but not less than $160,000 (unless you don't mind buying mobile homes) but you are not going to cover your costs as

(1) the rent for a 3 bedrom home is around $700-800 (and our property tax rate is $40/1000 of value and we hit them for the full market value as base.) That is all the market will bear for a 3 bedroom HOUSE! A 2 bedroom apartment gets around $500-650 with the owner paying heat, trash, and water and sewer.. Buy a duplex or 4 flat? Same problem - the sellers want more than it can possibly return in rents. I have been advising someone how is looking for income properties and who has the cash to spend. We put the whole project on hold.

(2) appreciate? Based on what? It is not just CA where prices are falling. In my village, every piece of property just took a hit of 29% downwards.

Nothing had sold in nearly 20 months except for 2 places that were word-of-mouth, no realtor involved, and sold at a price the median income could afford. The 2nd homeowners are flooding the market with listings up 400 -600% over normal. Finally an summer home sold through a realtor. It sold after they reduced the price by 29%. It sold for 18% less than the listing price on the model home in the same small development (20 lots with 15 developed) where the developer has already slashed the price by 15%.

There are 2 identical lots (size, minimum size house allowed) for sale in that development. Orginally the lots were priced at $75-115,000. These 2 lots were in the $75ish range. One seller has dropped to $64 and other seller is more desperate - they went to $48,000 and it has not sold.

There are other lots for sale at $55,000 (1/4 - 1/2 of the size of the ones described above) - 150,000 (same size) in the village. Needless to say, those small developments haven't sold anything and now won't sell anything until their prices drop a LOT!

Since all of these properties are located in an area with 176 homes and in a 1.2 sq mile area, yeah, the selling listing prices that are falling have a huge impact.

And by the way, I never believe anyone who says something is working financially unless I see they balance sheet.

Want to purse that course? Come on out here and buy a 4 unit apartment building for $292,000. Of course the units only rent for $650 inclding heat, trash etc - and it has a 25% vacancy rate but it is a nice building in a quiet area......

[Blissful Ignoramus]

Again, that's reasonable, but it's probably not going to happen. Nothing in recent American economic history indicates that it will happen. We are not a nation of savers. You may think that is wrong, or foolish, or unsustainable, but it is fact.

Well, then it's a fact that people should have to wait out the real estate bubble before purchasing.

I bought my first house in 2000 (not in California), and the expectations were straightforward. You put 20% down. As a first-time buyer, you could put as little as 5% down, but you had to pay PMI - even an 80/10 was not easy to get. PITI could not exceed about a third of your gross income. Sure, some people were starting to get around these rules, but it was considered dumb, and lenders weren't barging your door down trying to lure you in.

These were reasonable standards that most people had to work toward to buy a house for many years, and the real estate frenzy of the last decade has thrown reason out the window. Prices are too high for a large majority of people to be able to afford mortgages. Well, guess what. Prices are just going to have to come down.

[investorguy]

Uh, SDDan... you wrote "People are more than capable of 'scraping together' sums of $20,000 or $30,000 when they buy that shiny new car on a car loan."

That's not saving. That's borrowing.

[Pat]

What is a first time home buyer? I have seen definitions where if you haven't owned in 5 years, you are considered a first time home buyer. By a strict definition, I am not a first time home buyer. However, by the second definition, I am a first time home buyer. I have $120,000 saved for a down payment and am hoping to get to $140,000 by the end of the year. My hope is that by next year $700,000 actually gets you a pretty decent SFR/TH/Condo (2+ BR, 2+ BA, ~1500 sq. ft.) within reach of a cooling sea breeze.

[anon1137]

A capitalistic economy can't survive without savers. Our buy-on-credit society has only developed in the last 20-40 years and it's not sustainable if we want our successors to have a growing standard of living. Parents need to teach their children to save and reward them for doing so. When home prices come back down to reality, it won't be such a burden to come up with a 10% down payment.

What's more disturbing to me is the number of borrowers who can't document their income. This points to a growing cash-based economy of workers who are avoiding the tax system. The government needs to get to the bottom of that.

[investorguy]

AnnS: You can do it in Detroit, Kansas City, Indianapolis, Rochester, Toledo, parts of North Carolina and other markets. I do it in Detroit, and I have friends who are investing in those other markets and making money. Buy an REO for $30K or less, rehab it for $10K, rent it for $750/month -- more if you go Section 8.

I don't know where your "village" is, and it doesn't really matter. That's not a market I would invest in. But open your mind -- your experience is not everyone's experience, and your town is not everyone's town.

But that's why some of us make money, while others like you whine about how it "can't be done."

[sheila]

my two cents:

20% is too high in LA for renters paying $1600/month for a 1-bedroom, and $2,000/month for a 2-bedroom with all decent (not great) houses and condos running $650K to $1,200,000. and yes, you will find that most young professionals with good jobs pay this much in rent.

horrible fixer dumps in dubious neighborhoods are $400,000, so even those will require $80,000 plus closing costs (say another $10K). if you've gotta have 3 months' reserve living expenses in the bank, that's gonna be another $23,000 (based on $2500/month PITI at about 33% of monthly expenses).

so, really, for a complete wreck fixer on a tiny lot in inglewood or south LA, or a teensy apartment, you'd have to sock away about $115,000 in cash before buying. with no money down, the difference in your mortgage and your 1-bedroom rent is only about $600 - $1,000/month, plus a few hundred in taxes, insurance, etc. which actually may be do-able, especially with the tax savings. but if that is roughly what you can afford each month, then you can set aside about $1,200/month for a down payment, and that will take 8 years.

since this income level (roughly $125K) is not only rarely achieved by most angelenos, much less, most angelenos under 30, and since often, you have to pay off extortionate educational expenses for 15 years after grad school to hit that level of income, hat means we will have to wait till we are 42 - 50 to get into that crappy little fixer, and pay out that kind of mortgage until we are... 72 - 80 years old!

sorry, at least for first-timers with no parental help on down payments, and no past equity to draw on, even for buyers in the top financial demographic, it seems like it will be absolutely impossible to buy a home in los angeles if we require this much down. if we drive all young, educated, hard-working people out of the city, we will see a lot more melting down than just the mortgage market.

[Small hat, a few cattle]

What is the big deal here? Saving is not that hard once you understand the power of compound interest/earnings over long periods of time. For those who don't want to change and don't want to save, thats fine. In the long run, they will not have the same opportunities to build wealth if they don't save and invest. Maybe a few get lucky by flipping a few homes with fraudulent loans but the majority will be living paycheck to paycheck always sweating over money issues. The savers and investors will be sleeping easy at night knowing that the majority of wealthy individuals don't make their fortunes overnight. Slow and steady wins the race.

It is amazing how little things can build. And it is amazing to see how cutting small expenses out of everyday life can create large savings. I never go to Starbucks, I try to cook at home as much as possible, I use a credit card with no annual fee and great cash back rewards, I don't go to expensive bars/clubs, I own my car outright (7 years old and was purchased used), etc etc...

One of the most important books I have ever read was "The millionaire next door". And for all the young 20-30 year old savers out there, I would recommend http://www.mymoneyblog.com/

It is very possible for someone in their 20s to live comfortably yet frugally in LA while saving almost 40% of their non 6 figure gross income...that is, as long as you are a renter.

[Kaye Thomas]

Ten years ago people saved to buy a home and made sure they had decent credit. Those were the rules and everyone knew what they had to do. Much has changed in that time frame. Until the government stops penalizing you for saving and encourages people to save it's just not going to happen.

The California real estate market is not going to collapse. Prices will adjust but not by 50%. People forget that real estate in CA has always been higher then in other parts of the country. You will never be able to buy a house in CA for the same price you can buy one for in Kansas... not going to happen.

There will be "new loans" that will be used in the higher priced areas of the country. You will not see prices in New York, Chicago or San Francisco drop by the numbers many are hoping for... it would ruin the entire economy therefor it won't happen.

[Kathy]

I freely admit I could be dead wrong, but I suspect that the coming tsunami of baby boomers without sufficient retirement savings is going to at least bring the topic of saving back into the political conversation, even by those who would see raising or rolling back taxes to fund retirement programs. If some of those same boomers were counting on their now disappearing equity to fund that retirement, well, that will just make the conversation a little more interesting. A statistic released this year said that the savings rate for Americans last year was negative, i.e., more was spent than even earned. All of these things separately are a concern; coming together at the same time seems likely to provoke change.

[investorguy]

anon1137: While there is a lot of that, many of the no doc folks work in industries like Hollywood where your income varies by the gig. You don't know your annual income until the end of the year -- so not everyone is a cheat. Some are just in occupations where they don't get the same paystub every week.

[Toby]

If we always insisted on a 10% down in the first place, we'd wouldn't be in this mess.

Because it's simple really, if you can't come up with the 10% of the house's value, then chances are, more likely than not,YOU CAN'T AFFORD THAT HOUSE.

Look it at this way, the mortgage on a 450,000 dollar house, even with 10% down, is roughly somewhere between 4,000 and 5,000 a month (depending on your interest rate).

So if you can't save 45,000 dollars in a reasonable amount of time (a few years), then you are either living WAY beyond your means OR you can't really afford a 4,000 to 5,000 a month mortgage to begin with.

Seriously, people, it's called "reality" , come, join me. Really, it's a better way of life.

[amir]

Now, then -- who's making the case for saving? Anybody? ... Anybody?

Reality.

When prices fall in LA to sustainable prices (50% down from the high) a 10% down payment will be $25,000. If you can't save that, then no, you won't be living in your own house. That's how it used to be in this country - and worldwide - and our reality will go back to the mean.

[BetterVillage]

Point long accusing fingers at Kawasaki (rich dad poor dad), Carleton Sheets, Tony Robbins, and all the other gurus with infomercials. Saving is for suckers, they say. You'l stay poor if you save. You must invest!

[Aaron]

It seems to me that Peter Viles's reasoning is working in the wrong direction here. He seems to be thinking that we ought to have ways of getting around the 20%-down requirement (whether through private market-driven forces or government assistance) because we are not a nation of savers. I think it makes more sense to think of it in reverse: we are not a nation of savers because we have ways of getting around the 20%-down requirement. In other words, if the quick-and-easy (and potentially market-distorting, as we have seen lately) routes to buying a home are closed off, we might actually become a nation of savers, depending on how badly people actually wanted to own their own home.

[Cal]

"It may be reasonable, but in this state it is not possible for many potential buyers. "

Which is why many people expect housing to go down so much.

For people like investoryguy who think lenders are just going to magically come up with a 100% product, or a low FICO product, or a no-doc product. The ONLY way they will do so if they are lending other peoples money so the "Other People" that have disapeared from the secondary market will have to come back and want the same junk they are absolutely rejecting now. Prudent lending simply speaks against all of those products (the 4 C's of lending). People think that all this stupid money that was pouring into mortgages will become stupid again after they just wised up. What would happen is the secondary market would step back, look at the situation and re-assess risk. The risk has been fundamentally mispriced, if they do come back with those products the risk premium would be much higher than it was to the point of being prohibitive.

Even a 5% down OR requiring documentation would change the housing market in CA in an extreme way. I dont think people will all of the sudden start saving and therefore wont qualify for homes. Or if they do start saving think about what that means for the local economy. I just think we have gone so far in this credit bubble (its a credit bubble that has affected asset classes such as housing, That is the bubble that has just popped) there isnt a non-painful way out.

People USED to save for a down payment, they've just gotten so comfortable the last 10 years (due again to the credit bubble which made credit available to anyone for anything) that they think its the norm instead of the exception. Cheap and easy access to credit is not a given, people are going to wake up to that reality very soon.

[Monkey In Chief]

The risk of default is MUCH higher as the down payment drops. Wall Street has been undercharging the risk on low down payment loans and the current credit crunch for jumbos is the markets waking up. Magic new products can not fix this problem. The risk is even worse in CA since its really hard to say what the value of the house will be to the lender if the loan forecloses. Regardless of what median price is, it takes a long time to sell properties in the current environment unless they are being offered at a sharp discount. An REO is non productive asset and holder needs a 0.5%/month gain during the holding period to compensate for holding it.

The foreclosure value problem is exacerbated if there is risk of a large drop in house values which I believe there currently is. To make matters worse, it's entirely likely that default risk is now correlated with the stock market (look at the how the stock market is dropping in response to the subprime crisis) and finance junkies will recognize this means that the beta on residential loans has gone up requiring higher risk premiums and thus higher interest rates on loans.

The root problem is that residential property is overpriced as an asset class in CA. There's going to be nobody to buy it at current prices since they won't be able to get loans since they don't have down payments. The old school rules about 20% down payments were right. When the dust settles, I predict that the combination of at least 20% down and high FICO will be shown to be low risk loans and every thing else to be much higher than the risk premiums the market was charging from 2004 to July 2007.

[RacerManTodd]

SD Dan says that you can save $260/mo and have $40k in 10 years.

I hate to be the bearer of bad news Dan, but in 10 years, I doubt that a $40k down will be 10% of the median home price in LA. I doubt it'll be even 5% at the way the market seems to move in LA County.

I know some people are able to save, and great for them, but those people are typically single, unattached and came out of college with no debt to begin with. People like myself who left higher learning with a BA and $50k in debt to start in the world, just never got the jump on the game.

[Grace]

We did it. We put 10% down and closing costs on our first home from our own savings.

We rented a condo in a safe but not fashionable area close to work. It was cheap and sufficed.

We shared an inexpensive car which we paid off in 3 years. Then we held on to it once it was paid off. We biked to work and used public transit some of the time.

We paid off our student loans on the 5-year payment schedule instead of the default 10-year schedule. Both of us went to grad school so we owed 25k between the two of us.

We ate one dinner out a week and cooked at home the rest of the time. We brown-bagged some but also went out to lunch with friends from work at least once a week.

Our idea of fun is to ride our bikes or go hiking. We watched rental movies at home or went out to revival movie houses. We invited people over for potluck. We read books from the library.

I didn't feel deprived at ll. We put a a little money aside for retirement at the same time, enough to take advantage of the employer match. We even took a vacation to France, riding our bikes from one inn to another.

When we shopped for houses near work, we could only afford tear-downs. We looked at townhouses. Initially, I wanted a better location but we ended up buying two blocks away from the small condo we had been renting.

It turned out that we have some pretty nice and helpful neighbors. In addition, test scores don't tell the full story about how your child will like the school. Our home is not in a "blue-ribbon" district, but it serves the needs of our child reasonably well.

We think the key is to live close to work or convenient transit and get rid of one car. It really helped us save.

[J White]

I feel like I have been living in another world...I have been buying real estate for the last twenty years and did not even know you could get a loan without a 20% down payment, good credit and proof of income...Where have I been?

[LA Expat in Arkansas]

"What's more disturbing to me is the number of borrowers who can't document their income" anon137

Anon, it's not that they can't document their income: they won't. Otherwise they'd never qualify for the house. When we read that $14,000/yr gardeners are buying $700k houses, it's clear that if they COULD document their income they'd never buy the house. Call the liar loans if you must, but the lenders are just as culpable for not requiring documentation.