Credit squeeze: The problem with down payments

News item, and then an e-mail from a reader. First the item, from Reuters: "As U.S. banks mop up the mess from billions of dollars of bad home loans, buyers are finding the days of cheap money are over and, in many cases, tougher versions of old lending rules now apply. ... Gone are the days when almost anyone could get a loan with a down payment of less than the traditional 20 percent."

Now the e-mail, from reader LTL: "Today I went online to try and see what I would qualify for if I tried to get an FHA loan. A bit about me, I'm 29, married, with two young children. I'm a lawyer, with household income of $225k/year. We recently relocated back to LA.

"Knowing that the new Freddie/Fannie limits had gone up, Today I went to the FHA website to see what I could qualify for. I saw that the L.A. County mortgage limit had increased to $729,750, which coupled with a 3% down payment, yields a maximum purchase price around $750,000. Or so I thought. Upon running my numbers (225k annual salary, $500/month car payment, $900/month education loan payment), I only qualified for a FHA loan of $362,790 with a 3% down payment of $10,973. It calculated a total monthly housing payment (PITI) of $3661, leaving me over 10k in left over income. 

"The same calculator also yielded what I would qualify for with a "conventional" loan. I apparently qualify for a " conventional" loan of $672,378 with a down payment of $118,655, for a total maximum purchase price of $791,033. My monthly housing costs would be $7,472, leaving $7,541 in remaining income. So that's almost 50% of my income (and I haven't figured out how the calculator figures my take home income) for housing.

"I don't think most people have my annual income, I feel very lucky to make what I do, and I know that census statistics back up my contention that the percentage of people who make more than me is very small. So obviously, the FHA loan program is of little use to buyers in L.A. If I can't qualify for the maximum amount, who can?  And if I went with the conventional loan, I would need over 120k in the bank for a down payment. How many people have that sitting around? Not many. Most buyers over the last few years have put nothing down, let alone 6 figures.

"I would especially be interested to hear what the real estate agents and Cal have to say about what they are seeing when people attempt to qualify."

Thanks, LTL. Before I ask for comments, an observation: I know many here believe the market should return to the days when a sizable down payment was required to purchase a home. If that comes to pass, the California market will remain weak for quite a while. If you take low-down-payment buyers out of this market, you shrink the pool of buyers sharply.

Your thoughts? Comments? E-mail story tips to peter.viles@latimes.com

Comments

[Milla]

thanks for posting this, pete. i got jumped on the other week for talking about low downs and 40-year loans, but without a little bit flexibility for the first-time buyers who are good credit risks and live in pricey markets, homeownership would be something reserved only for the rich -- and given LTL's case, maybe just the super rich.

i know, prices should fall until they're 3x one's income and all that, but with rising energy costs, food costs, healthcare costs, education costs and every other expense that's risen at the speed of light, 3x won't cut it either.

[Joe]

What's so surprising about that? A household with a 200K income should be living in a 500K home. The real estate market is still incredibly bloated as home values are way out of line in comparison to incomes. Market prices need to come down a lot.

[Pasadena]

I agree with LTL. I'm a lawyer, make $265K per year and have $180k for a down payment. I have a low car payment and low student loan payments. If I get a loan for more than $700K, it really starts to hurt and I would be stretched very thin. That means I could reasonably afford a $900K house. Unfortunately, all the available $900K SFH's are tiny (under 1700 sf) or too close to dangerous neighborhoods.

[Uncle Billy Climbs Mont Pelerin]

re the broker referenced in the zillow article: first of all, he's not a broker, he's licensed as a salesperson, reuters. 2nd... both he and zillow live in wacky world. The house is right on a fairway at the wilshire country club. Sounds like it should command a hefty price even in a down market, right? Reuters values his 6 bedroom, 6200 sq.ft. home at $6.2M. The salesperson has it on zillow at $7M. If you look around at the surrounding homes, they're all in the $1.3M to $2.3M range. His neighbour to the north has a 13,000 sq. footer with 9 bedrooms that is *zestimated* at $1.4M.

Now... his complaint: "I can't get one dime out. I don't like feeling like I'm trapped and I can't tap equity."

According to the article, he has $3.5M in debt on the house. Well, if only a nitwit would pay more than $1M-$2M for this place, he just won't get that big chance to "tap equity."

Dear Lord, there are 10's of thousands more just like him or more befuddled.

[Melissa]

I'm sorry, but not having a sizable down payment with that sort of income is quite ridiculous. My husband and I make a combined income of $106,000, and we were able to save and put down $105,000 for our first home purchase in Nov. People want to have their cake and eat it too, but sacrifices must be made (ie, less trips, less expensive cars) to invest in a home. Don't feel sorry for this guy.

[Roger]

I am not sure why people talk of 20% downpayment. I got qualified with Bank of America and Citibank with a 10% downpayment for upto $380K. I would put down 10%, so for a $400K home, I am can put down $40K. My annual salary is $120K. No debt, no car payment and currently rent for $2,200 in downtown LA. So of course I cannot buy in LA. So I am looking to San Diego area, far from the ocean, far from downtown San Diego. I see condo's for about $200k. I work from home, so don't need to commute. Anyway, point is I don't understand why the 20% is being thrown around, when I got qualified with a 10% down. And also, it obviously means people like me cannot afford LA at all,
so fewer buyers, should mean the prices will come down even more. Comments are welcome.

[Cal]

I just bet the calculator hasn't been updated, LTL should talk to 3 lenders, a broker, a big bank and a local credit union.

That will give him the breadth of the available products.

Stated income has very high down payment requirements (25-30% for many programs) and a 4506-T signed (they can check your taxes if they want). But the full doc stuff can still get lower than 20% down payments.

Returning to sound underwriting and reasonable down payments means a smaller buyer pool until prices adjust to the new reality. This new reality looks a lot like the previous years before subprime and securitization. It is just people look at the past few years and can't imagine things being anything but like that.

It isn't my decision or your decision, its the banks decision of what constitutes sound underwriting. The boom happened because sound underwriting was lost. The return to it will be painful for some and welcomed by others. But the whole issue boils down to that it should never got to that point to begin with. But politicians being politicians will try to "fix" things by "solving" the issue and creating programs with low down payments. All that will do is ensure that taxes go higher as we pay for bad underwriting.

[skepti-Cal]

"I apparently qualify for a " conventional" loan of $672,378 with a down payment of $118,655, for a total maximum purchase price of $791,033. My monthly housing costs would be $7,472".
----------

Fuzzy math.

Just put these numbers into a very cool housing cost calculator:
http://www.arooly.tv/financedisplay.php?tool=2

$790K purch
$118.5K (15%) down
5.75% First
7% Second
1.125% Tax
0.250% Insurance

Monthly payment: $4856

That's a +/-$2600/mo difference.

You sure you entered the numbers right?
Even with a 8% First and 10% Second I get just $5889.

A 10% First and 12% Second only gets to $6858.

Just how bad is your credit????

[mrincomestream]

"...Thanks, LTL. Before I ask for comments, an observation: I know many here believe the market should return to the days when a sizeable down payment was required to purchase a home. If that comes to pass, the California market will remain weak for quite a while. If you take low-down-payment buyers out of this market, you shrink the pool of buyers sharply..."

And what exactly is your point...would you rather folks continue to lose their homes enmasse because they strayed away too far from the fundamentals or a return to a somewhat rational market...

The guys email shows you just how out of whack the market is here in Los Angeles...

[tealeaf]

This is precisely the issue: credit remains much tighter than the past few years.

It is the perfect corrolary to the crazy, suicide loans that drove the prices up - including "high end areas" (inflated by surrounding values, which have cratered).

Real value was not created during this period: we
solved for asset value based on an exploding monthly payment granted to folks who couldn't otherwise get into the home.

And it all happened on the margin - both up, and now down.

[Anthrodiva]

We live in Riverside, not LA, and make as a household 100K, and not 225. We are closing on a 2000 sq ft house on .3 acres for 291K on an FHA with 3 percent down and we have found the process to be a breeze.

Of course, we did our homework and have money in the bank, but things are nowhere near as dire as this guy paints them out to be.

Oh, and that house? 50% discount from 2006. An REO priced at $134 per sq ft whihc is where I figured Riverside should be based on the Case-Shiller index. There are still nutballs out here crossing their fingers and hoping the sky will stop falling, but banks are not among them.

[tealeaf]

Cross linked from the article referenced above:
http://www.cnbc.com/id/24774352

"Combine the high loan-to-value ratios with falling prices and homeowners saw what little equity they had disappear, and with it their ability to refinance into a more sustainable mortgage and their incentive to try to stay in their homes."

[Roger Moore]

"And if I went with the conventional loan, I would need over 120k in the bank for a down payment. How many people have that sitting around? Not many."

Not many people have that much "sitting around" because most people have gotten out of the habit of saving. Back when 20% down was normal, it was also normal to save for years to be able to make the down payment. Switching from 0% down to 20% down being the norm is going to be a major shock to the system, but people will adapt pretty quickly if they learn that's what it takes to get the house they want.

[bob]

What this tells me is the real estate pricing floor is too high. The market has another 15 to 20 point decline before prices equalize. This represents another 100,000 plus equity dump. Secondly, as the market equalizes pricing, we could see a return to "Creative Financing" gimics that dominated the 80's housing market when inflation was running at 12% and interest rates were 18%.

In addition, the increase in court house steps foreclosure sales should not be extrapolated as a bottom to the market. Rather it should be intreperted as the real estate market equlibrium point.

We are no where near the bottom of this market

[Steve]

It is simple move, as a lawyer you will make onaly 20% les, yet housing is 50% out of state.

[david]

Aww, the beauty of paper money, the banks can make as much as they want and give/lend away just as much.

America needs a home loan of $13 trillion when there isn't that much money to being with? No problem, the government can make them as fast as you can press the enter key.

Was it Mark Twain who said that inflation is the first sign of a mismanaged economy?

BUY SILVER AND GOLD, PEOPLE. You still have time to save yourselves.

[Laker]

Peter, so what do you suggest? Bringing back stated income with neg Am loans and ZERO down???
What do you want the bank to do if they see houses falling 20% annually?
One of thing we see that borrower is defaulting after being in the house for 8-24 months. That means, there is a huge chance the current borrower will default if the market will be 20% down next year. Banks know that and most sane banks require 20% down. That will be a cushion in case it does happen. Anything lower than 20% and the risk is really to big.
If the big shot lawyer can't find $100,000 cash in his bank account for a down after pulling in $225K a year...he should not buy a house. Obviously he lacks the ability to control money. With such an income, you should be able to rent for 2-3 years and easily save $100,000-150,000 in the bank.
People that have only $10,000 in their whole savings, should not be in the business to buy houses, THEY SHOULD RENT !!!!
Why is this so hard to understand, If i don't have the money to buy Lamburgini, I don't buy it. Loans less than 20% in cash down do bring skin in the game, they just enable gambling and craze and should be against the law. During the 90's bust there were many people that lost homes to foreclosures after having put down payments of 10-20%....Today we see foreclosures because there was 0 down. That is enough info to guarantee lifetime record of foreclosures and you know what that means...

[x-man]

What a story from the frontlines. Volumes of truth contained in this anecdote. Proves the run up in prices wasn't about demand, it was about easy money. Now that the credit tide has turned, coupled with foreclosures (now commonplace in Los Feliz and Beachwood, even showing up in the Platinum Triangle), the westside is relegated to the same fate as the inland empire: 60% off from peak pricing.

[E]

10% down w/ PMI, 20% down without it.

So...as Pete says, it leaves some people out of the housing market. Supply & Demand create rational prices. Perhaps the 5% down that a person might have had will become 6-?% down as prices normalize. Meanwhile, it also gives them time to prioritize their expenses and if buying a house is a priority, they will sacrifice other things in order to save up that 10-20% down. Some will be able to get help from parents, some won't. That's life.

[Mmm... donuts]

In my view, shrinking the pool of buyers is fine and even desirable. A large portion of the new buyers over the last few years really should have still been renters all along. Requiring a commensurate down payment is a time-proven method from ensuring people take the obligation they're entering into seriously.

[Danny]

I've been saying it all along. The knife-catchers who are currently buying houses are a very small subset of buyers - those with cash-on-hand for the 20%+ down payment. The numbers of these buyers are dwindling fast. And pretty soon even those who think that buying a house at 20% off-peak pricing is a good deal won't be able to make that (stupid) decision to purchase. They just won't be able to get the loan. When prices fall to the point where people once again can make a 20% down payment, then we will have reached the bottom. And that will happen when prices are in line with medium-income. And that will happen when we return to around 2001 prices. There's no stopping this train. Banks aren't going to make any more risky loans. There's nothing in it for them. There used to be, back when everyone wanted to put all the world's capital into mortgage-backed securities. Now that real estate investing is taboo, there's no reason for the banks to take a risk on mortgages.

I'm a little confused with the poster's numbers, though. What kind of sky-high interest rate was the bank quoting him to give him a $7400 monthly cost on a $791,000 house. Even with 0 down the monthly cost shouldn't be that high.

[Josh]

Interesting post. I agree that if Southern Californians need to put 20% down, housing prices will reset much lower over the next few years since savings rates are negative in this country right now and we in SoCal are known to live well beyond our means.

That being said, check out yesterday's Santa Monica Distress Monitor post on people who are waiting on the westside. The majority have substantial incomes and downpayments:

http://smdistress.blogspot.com/2008/05/
tell-us-about-you.html

[perks]

LTL: I plugged in my own income/expense numbers, and the FHA site "qualified" me for the exact same amount: $362,790. It gave me the same figure if I entered my income at $900k per year (I assure you, it really isn't!).

I don't think the days of the traditional 20% down are headed back in the immediate future; the sad truth is, the market would collapse entirely if they did. Anecdotally, I know from friends in the mortgage industry that to this very day you can easily find loans of up to 95% LTV through major lendors (BofA, for example); the only catch is that--imagine this--you have to have decent credit and be able to document your income.

[E]

OK...after reviewing the story, let's run the numbers.

We have Manny Torres, a "freelance T.V. camera operator"...who before deducting for work expenses and health care makes $100,000 annually.

Does he make that *every* year? How far back can he document his income? How many "lean" years did he have and how "lean" were they?

Moving on...His work related expenses are set. He *doesn't* make $100k. He makes $70k. Period.

He bought a 600k place on a 70k income whereas he really could afford only a 280k place if he were stretching. He depends on $2000 month from his rental to cover an additional 320k worth of a mortgage. Not to mention that he has more sf to maintain, higher taxes, income tax on the rental income (I assume). When/If the tenant moves out, how long will it sit vacant? That is an unknown.

Oh...yeah...do all those actors/writers/etc. strikes affect his job? How stable is it *really*? I hear it's pretty dog eat dog in the industry. Could a younger and hungrier TV Camera operator underbid him?

He's already stretching. I wouldn't loan him any money either.

Next...let's look at the other candidate. Craig Van Skaik.

He's a mortgage broker. How is his income this year compared to the bubble years? He is $3.5M in debt. Run the figures on how many $3.5M+ houses have sold in the last 6 months. Compare that to the inventory (don't forget about those "pocket listings")...pretty healthy MOS.

Why does he need the money? To keep himself afloat? To service the $3.5M in debt that he already has? Who knows...but if so...isn't that just "robbing Peter to pay Paul"?

Let me propose this question to you Pete. If you had the money...from the little bit of information that we get from the story...would *you* lend it to these people?

[IToldu2CashOut]

Interesting. I am the opposite. I could put 20-45% down if I wanted, but only make 80k. Have over 200k saved. I do pretty well in buying and selling stocks ontop of what I get from a salary. I just can't see a house as a good investment when I make 10-20% on my money investing and housing will continue to decline. Once houses reach a reasonable price I will reconsider. I just don't want to have 60% of my income going to a house payment. Would change my lifestyle bigtime since now I pay $1100.00 and live on the westside. Just doesn't make sense to buy when you can rent for 1/3.5 the price. Its not always what you can do, but what you should do and what actually makes sense. Right now it makes sense to wait. Renting is saving money. Buying is throwing money away for now.