Recently, there has been a lot of talk in the media and blogosphere relating to the large number of people in trouble with their mortgages.  BusinessWeek recently published a very biased article on the woes of homeowners who took zero-down mortgages entitled Nightmare Mortgages (read the National Association of Mortgage Brokers’ response here), Housing Panic comments today on the massive number of foreclosures in Atlanta, and “In Cash Flow We Trust recently posted about foreclosures in Denver leading the nation.  So even though we haven’t gotten anywhere close to discussing buying a home, I thought I would share my take on the issues of so-called “exotic” mortgages and the trouble they appear to be causing.

Often, individuals and couples with poor credit have very few options when it comes to financing a home purchase. With good credit and 20% down, you can qualify for great rates and a wide spread of loan products - but if your credit score is 620 and you can only bring 2% to closing, your options are much more limited. Often, the only loan products available feature adjustable rates, often with 2-3 year prepayment penalties….and usually come at high interest rates (2-5% higher than market average). However, if the new homeowner makes on-time payments until the prepayment penalty expires, the resultant increase in their credit score will make it possible to refinance into a fixed loan product that they simply couldn’t qualify for when they bought the home, and at a better interest rate.

For a responsible young individual without a lot of credit history or assets, a zero-down loan can be a launching pad into the higher net worth and financial stability that often accompanies home ownership.  You just have to make your payments.  Adjustable rate mortgages with a fixed period of 5-10 years can be a great money saving tool for young couples who do not intend to hold their property for more than the fixed period of the loan.  If you intend to sell in 5 years, then buying a home with a 30 year fixed mortgage often doesn’t make sense.  Remember though to leave yourself some leeway in the fixed period of the loan to refinance or sell the property when the market is favorable. 

Zero/low down payment and adjustable rate mortgages are not to blame for the spate of foreclosures in Colorado, or anywhere else. There may be a correlation between holders of ‘exotic’ mortgages and foreclosures - but it is the borrowers rather than the mortgages who are at fault. Simply put, if you cannot even save 5% of the purchase price towards buying a home, you are more likely to live paycheck-to-paycheck, and miss payments when finances get tight. Borrowers who can save 20% for a new home obviously have better savings habits (or more financial resources) - and likely have emergency savings that let them weather downturns in cash flow.

As a mortgage broker, when I sit down with prospective borrowers, I explain to them that what I can ‘qualify’ them for is much more than most people are willing or able to pay. I give borrowers as many options as their situation allows, and once we’ve arrived at a monthly payment amount, ask “is this a number that you are comfortable paying each and every month?” It is the responsibility of the borrower to decide if they can handle those payments.

Ultimately, people need to stop buying houses that they cannot afford.

Buying a home is a wonderful step in your financial life, especially for a twentysomething.  It can open the door to higher net worth through property appreciation, principal (loan) pay-down, and tax deductions.  If you have limited assets and weak credit but still want to buy, only buy if you can afford the fully-amortizing payment, which willl result in the loan being paid off at the end of the term.  Zero-down and/or adjustable rate mortgages may be the most appropriate products for you, but I would try to avoid negative amortization loans or pay option arms, where your payment may not even cover the interest on the loan - which is then rolled back into the loan, reducing your equity. Interest-only loans are somewhat less risky, but generally most appropriate for real-estate investors.

Ask questions of your mortgage broker.  Don’t sign anything without knowing what it means.  Most brokers are honest, depending on referral business, and cannot afford to scam you.  If you can put down even 5% of the purchase price, you’ll benefit significantly.  Your best option is to keep your credit score high, put down 5-20% on the purchase, and keep a healthy emergency savings account to help you through any financial difficulties.

We’ll examine buying a home in greater detail as we move along with The Plan.

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This entry was posted on Tuesday, September 19th, 2006 at 11:57 am and is filed under Buying a Home, Mortgages. You may e-mail this post to a friend. You may print this page. You can leave a response, or trackback from your own site.